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July 10, 2011

The use of Exchange-Traded Funds (ETF) is increasing

ETFs were introduced in the US in 1993.  There is about $1.2 trillion invested in close to 1300 ETFs today.  Some of the advantages are: lower-costs, tax savings, continuous trading, efficient portfolio construction, and transparity. 
There are critics of ETFs.  They are concerned that it encourages over-trading.  ETFs have been used for frequent trading rather than long-term investing. 
Another concern is that some ETFs that were designed for a narrow focus of the market or trading strategies.  Investors may not  understand the product, segment of a market or investment strategy.  These ETFs require analysis and an in depth understanding of a small proportion of the market they were designed for.   
Some funds are so specialized that there are not enough investors interested in them.  If the ETF cannot be profitable it will be closed.  This can have negative investment and tax consequences.  
ETFs may not be availble in employer-sponsored 401(k) plans.  The pricing of an ETF and transaction costs may create administrative barriers for employer-sponsored 401(k) plans.   
ETFs will continue to grow.  There will still be a need for mutual funds.  Many mutual funds are making changes to be more competitive to ETFs.  Each investor must pick the product that meets their unique situation.  Investors must understand the products they are using  to make the right choice in constructing their portfolios. 

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