ETFs offer opportunity for the active investor

Today's Wall Street Journal took a look at exchange-traded funds, which seem to be gaining in popularity every week. According to recent data analyzed by the Journal, traditional index funds outperform their exchange-traded counterparts, but only by a tiny margin.

Given the closeness of returns, most experts agree that it depends on the fund. The race is "too close to call" to say that investors should simply avoid ETFs.

However if you're planning to try to "time the market" rather than buy and hold the same funds for decades, I would argue that ETFs are the clear favorite. With markets becoming increasingly efficient, finding attractive opportunities can be difficult. While traditional mutual funds only offer you one opportunity for the market to be wrong (the prices of the underlying securities being undervalued or overvalued), ETFs offer two opportunities for market inefficiency: The prices of the underlying shares could be inefficient and/or the price of the ETF might not be an accurate reflection of the value of the stocks.

For instance, when investors are exceedingly bullish about a sector or index, ETFs can trade at a large premium to the value of the underlying basket of stocks -- That may present opportunity for aggressive investors. You simply cannot find opportunities like that in traditional mutual funds.

So here's my advice: If you're going to buy and hold for the long-term (the best strategy), you should probably go with traditional mutual funds. If you're going to jump in and out and try to take advantage of market swings, ETFs are for you. But you'd still probably do better buying and holding.