Quiz | February 2010

Prosper With Exchange-Traded Funds

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With total assets approaching $1 trillion, ETFs are quite the popular investment these days -- and for good reasons. They have several advantages over traditional mutual funds, although they also have a few drawbacks. This Kiplinger quiz delves into the details. See how well you know ETFs by answering our ten questions.

Quiz

Prosper With Exchange-Traded Funds

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Question 1 of 10

What are exchange-traded funds, anyway?

A. Mutual funds that are sold by the stock exchanges
B. Mutual funds that trade like stocks
C. Hedge funds
D. The best way to get rich fast

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Prosper With Exchange-Traded Funds

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Question 1 of 10

What are exchange-traded funds, anyway?

You're right! B. Mutual funds that trade like stocks is correct.

Sorry, wrong! is incorrect.

The right answer is B. Mutual funds that trade like stocks.

Unlike traditional index funds, which are priced just once a day (at 4 p.m. eastern time), ETFs trade throughout the day. You buy and sell them through a broker, just like ordinary stocks. But ETFs provide the "cushion" of mutual funds, bundling investments in many companies rather than just one.

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Prosper With Exchange-Traded Funds

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Question 2 of 10

What other aspect of ETFs makes them so appealing to investors?

A. Their tax-free status
B. Their low maintenance fees
C. Their increasing popularity
D. All of the above

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Prosper With Exchange-Traded Funds

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Question 2 of 10

What other aspect of ETFs makes them so appealing to investors?

You're right! B. Their low maintenance fees is correct.

Sorry, wrong! is incorrect.

The right answer is B. Their low maintenance fees.

Because most ETFs are index funds or own the major companies in a particular sector, they are cheap to operate. The expense ratio of a typical ETF that invests in large, growing companies, such as iShares Russell 1000 Growth Index, is a mere 0.20%. That means for every $1,000 worth of the fund you own, you pay just $2 in expenses annually.

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Prosper With Exchange-Traded Funds

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Question 3 of 10

You are qualified to invest in ETFs if you ...

A. Have at least five years of investing experience
B. Have at least $1 million in assets
C. Have a pulse
D. Are a certified financial planner

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Prosper With Exchange-Traded Funds

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Question 3 of 10

You are qualified to invest in ETFs if you ...

You're right! C. Have a pulse is correct.

Sorry, wrong! is incorrect.

The right answer is C. Have a pulse.

Anyone can invest in ETFs. You need only enough money to buy one share to get started, and you don’t need a PhD to understand the benefits of simple, low-cost index investing.

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Prosper With Exchange-Traded Funds

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Question 4 of 10

ETFs track only U.S. stocks and only major market benchmarks, such as Standard & Poor’s 500-stock index.

A. True
B. False

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Prosper With Exchange-Traded Funds

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Question 4 of 10

ETFs track only U.S. stocks and only major market benchmarks, such as Standard & Poor’s 500-stock index.

You're right! B. False is correct.

Sorry, wrong! is incorrect.

The right answer is B. False.

ETFs track everything from bonds to Turkish or Russian stocks to wind-power companies to the price of livestock. It’s another appealing feature for investors who like to put their money into investments they feel they know something about. As of December 2009, there were 924 exchange-traded funds, up from a few ten years ago.

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Prosper With Exchange-Traded Funds

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Question 5 of 10

What’s the biggest drawback of ETFs?

A. Pesky brokerage fees you pay each time you buy or sell
B. You can’t hold them in an IRA or 401(k)
C. They have expiration dates

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Prosper With Exchange-Traded Funds

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Question 5 of 10

What’s the biggest drawback of ETFs?

You're right! A. Pesky brokerage fees you pay each time you buy or sell is correct.

Sorry, wrong! is incorrect.

The right answer is A. Pesky brokerage fees you pay each time you buy or sell.

You have to pay a brokerage commission when you buy ETFs. So it can be expensive to buy a small number of shares (a $10 commission on a single $40 ETF share would immediately put you 25% behind, for example).

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Prosper With Exchange-Traded Funds

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Question 6 of 10

ETFs are more tax-efficient than actively managed mutual funds.

A. True
B. False

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Prosper With Exchange-Traded Funds

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Question 6 of 10

ETFs are more tax-efficient than actively managed mutual funds.

You're right! A. True is correct.

Sorry, wrong! is incorrect.

The right answer is A. True.

By tracking indexes that don’t change much, many ETFs avoid big capital-gains distributions -- although you may make up for this with the taxes you pay after you sell your shares.

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Prosper With Exchange-Traded Funds

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Question 7 of 10

When comparing ETFs, investors should consider ...

A. The expense ratio
B. The underlying index
C. Fund size
D. All of the above

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Prosper With Exchange-Traded Funds

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Question 7 of 10

When comparing ETFs, investors should consider ...

You're right! D. All of the above is correct.

Sorry, wrong! is incorrect.

The right answer is D. All of the above.

Costs, the underlying index, and the size of the ETF (generally, larger funds are more liquid and easier to trade) are all important considerations.

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Prosper With Exchange-Traded Funds

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Question 8 of 10

Can a regular mutual fund that owns stocks and bonds also own ETFs?

A. No, never
B. Only if they are managed by another fund company
C. Yes
D. Yes, but not if the ETFs use leverage or other trading strategies not allowed in the fund itself

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Prosper With Exchange-Traded Funds

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Question 8 of 10

Can a regular mutual fund that owns stocks and bonds also own ETFs?

You're right! C. Yes is correct.

Sorry, wrong! is incorrect.

The right answer is C. Yes.

ETFs are publicly traded securities, with daily pricing and liquidity, so they meet funds' eligibility requirements. Some funds that own ETFs (such as general bond funds) just want to have an allocation to an index. ETFs give institutions the ability to buy and sell a whole sector or market throughout the trading day.

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Prosper With Exchange-Traded Funds

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Question 9 of 10

The ETF was invented ...

A. By the New York Stock Exchange in 1973
B. By Warren Buffett in 1983
C. By the Toronto Stock Exchange in 1993
D. By Merrill Lynch in 2003

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Prosper With Exchange-Traded Funds

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Question 9 of 10

The ETF was invented ...

You're right! C. By the Toronto Stock Exchange in 1993 is correct.

Sorry, wrong! is incorrect.

The right answer is C. By the Toronto Stock Exchange in 1993.

The first ETF was invented in 1993 as a quick way to buy and sell baskets of stocks on the Toronto Stock Exchange. The concept was quickly adopted for Standard & Poor’s 500-stock index in the U.S. Now, ETFs apply to every imaginable investment category.

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Prosper With Exchange-Traded Funds

Question 10 of 10

What do ETFs not track?

A. Nanotechnology stocks
B. Stocks that Warren Buffett owns
C. Foreign inflation-indexed bonds
D. The Peruvian stock market

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Prosper With Exchange-Traded Funds

Question 10 of 10

What do ETFs not track?

You're right! B. Stocks that Warren Buffett owns is correct.

Sorry, wrong! is incorrect.

The right answer is B. Stocks that Warren Buffett owns.

Most ETFs cover familiar categories, such as growth stocks or Treasury bonds. A few, though, are quirky. Some track nanotechnology stocks, vaccines or other ridiculously thin slices of the market. However, none tracks the holdings of the Oracle of Omaha.

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Prosper With Exchange-Traded Funds

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Quiz | February 2010

Prosper With Exchange-Traded Funds

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Prosper With Exchange-Traded Funds

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