Forget Mutual Funds -- Try This Simple, Low-Cost Alternative Instead

As the stock market surged ever higher in the 1990s, many investors were content to let mutual fund managers find the right stocks for them. After all, the nation's leading mutual funds were racking up stellar gains, and it was of little concern that investors had to pay 1% to 3% in annual fees for the high-priced salaries paid out to many fund managers.

But in the next decade, parking your money in a mutual fund no longer seemed such a wise move -- many of the most popular funds failed to even keep up with their benchmarks (such as the S&P 500 or the Nasdaq Composite Index). Add to that the funds tacked on onerous management fees.

Investors have had enough, and they have been pulling out of mutual funds steadily in the past five years. In fact, with $11.6 trillion in mutual fund assets at the end of 2011, investors took more than $125 billion out of stock-focused mutual funds in 2012, according to the Investment Company Institute (ICI).

Where's that money going? Exchange-traded funds (ETFs), which trade on the major stock exchanges with their own ticker symbols.

These funds, which first appeared roughly 20 years ago, allow you to target specific investment angles such as gold, energy and even foreign countries. Yet they do so without the active hand of a high-priced fund manager. Instead, ETFs are generally "passive," which means they own a select group of stocks (or bonds) and then hold them for a very long time. That means lower trading costs and very little management overhead, which adds up to much lower annual expenses.

For example, the Fidelity Advisor Large Cap B fund charges 2.04% in annual expenses. The fund owns a range of blue chip stocks such as Apple (Nasdaq: AAPL), JP Morgan (NYSE: JPM) and Chevron (NYSE: CVX). In contrast, the SPDR S&P 500 ETF (NYSE: SPY) owns a very similar basket of stocks and charges just 0.09% in annual expenses. In effect, that Fidelity fund would have to generate annual returns of at least 2% just to deliver the same net-of-fees result as the ETF. (more)

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