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What is the difference between exchange traded funds and index funds?

"Exchange traded funds (ETFs), are the investment world's equivalent of a nectarine - part mutual fund, part stock, but a marvelous improvement over both."

Those words kick-start the recently published, The New Investment Frontier: A Guide to Exchange Traded Funds for Canadians, by authors Howard J. Atkinson and Donna Green. Whether you compare these investments to nectarines or watermelons, exchange-traded funds have quickly emerged as one of the hottest commodities in the financial industry. Canada has gone from one ETF available to 1415 in just over two years and more than 150 ETFs trade globally. Introduced to the average investor by Barclays Global Investors Canada Ltd. in 1999, the investment product has grown into a trendy multi-billion-dollar industry. ETFs are now offered by Barclays Global Investors, State Street and TD Asset Management. Exchange traded funds, similar to mutual funds that buy and hold a basket of stocks that mirror a particular index, actually trade as stocks on the exchanges. Index mutual funds, on the other hand, track an index but don't trade as stocks. As well, actively managed funds have the added feature of a manager who can adjust the fund's holdings and weightings. ETFs versus index mutual funds: A word of advice: ETFs and index funds come in all shapes and sizes. Compare apples to apples by deciding which index-based investments suit your particular taste, risk tolerance and financial goals. Look at the track record and the management team of the respective ETF or index fund. As with most mutual fund investments, you need a reasonable time frame to offset market swings and dips.