Exchange-Traded Funds Beat Active Managers

The largest, most popular ETFs mimic major indexes: the SPDR, tracking the S&P 500; PowerShares QQQ, tracking the Nasdaq index of 100 large non-financial companies, especially techs; iShares MSCI Emerging Market Index ETF; and iShares Russell 2000 Index of smaller companies.

ETFs for industry sectors gain or lose investors as market sentiment changes. Right now, the Financial Select Sector SPDR is getting a lot of play. Sector ETFs simplify your life because you don't have to research each stock separately, said Tom Lydon, editor of ETFTrends.com and co-author (with my Bloomberg colleague John Wasik) of "IMoney: Profitable ETF Strategies for Every Investor."

Beyond performance, ETFs have two other things going for them. They charge lower annual fees than managed funds, and, in most cases, they offer an edge to taxable investors. ETFs rarely distribute taxable capital gains during the time you hold the investment, as many traditional funds do. You usually don't have to book any gains until you sell your shares.

In one investment sector, the major ETFs fall behind. They usually don't beat low-cost traditional index funds, such as those offered by the Vanguard Group and Fidelity Investments. These funds not only charge low fees, but you can add to them, reinvest dividends and make withdrawals without paying brokerage commissions or other trading costs.

Where ETFs shine is against the higher-cost managed mutual funds.

Scott Burns, director of ETF analysis at Morningstar, said indexing usually grabs more market share during slowdowns, when managers underperform. But when stocks turn up again, a certain percentage of retail investors go back to chasing funds they think can beat the market. "To be an index investor takes a great amount of discipline," Burns said. But worth it, in the end.

Jane Bryant Quinn, author of "Smart and Simple Financial Strategies for Busy People," is a Bloomberg News columnist. Alexis Leondis contributed to this column.