When someone is seeking investment advice, the subject of exchange-traded funds (ETFs) often arises since they are becoming a popular investment vehicle. ETFs are a great way for someone with a small amount to invest to get a decent investment. In order to use this type of investment to your advantage, you have to understand how they work.

You are probably familiar with mutual funds because they are more common. Mutual funds and ETFs are similar in some respects. Like a mutual, an EFT holds multiple investments within it. Unlike these funds, ETFs are traded through an exchange, like NYSE, and are not purchased from an issuing company. Other differences are the redemption structure and the tax efficiency.

ETFs have some distinct benefits that mutual funds do not have. Here are five of benefits:

1 – ETFs are an attractive investment because of intraday pricing. This means they are traded on an active stock exchange so the sales are immediate and not based on the price at the close of trading. Essentially 
this means you could purchase ETFs at a reduced price or get a premium when selling them.

2 – Tax efficiency makes ETFs much more attractive than mutual funds. When a fund is sold, there is typically a capital gains distribution. When you sell an ETF, there are no gains to be distributed. However if a major component of the ETF is changed, it may trigger a distribution of gains.

3 – Exchange-traded funds are beneficial because they have much lower fees than mutual funds. Since an ETF is a no-load fund, you do not pay redemption fees when you decide to liquidate it. They also tend to have much lower annual fees. Although rare, on occasion the fee can be higher.

4 – Unlike many mutual funds, exchange-traded funds do not require a minimum investment. With a fund, you often have to invest at least $2,500 dollars. Since this is not true of ETFs, they are great to diversify your investments.

5 – Another major benefit of exchange-traded funds is their liquidity. That means you are able to keep your portfolio balanced by using your ETFs for the liquid component. You can even set a limit just as you would with stocks, which makes for more flexible trading that you could never get with a mutual. Remember to check your ETF, because they do not have all this liquidity.

Although the points laid out are benefits, they can quickly become liabilities. So remember to be careful when buying and selling ETFs. They are a great way to diversifying a smaller investment but do require you to ensure they are managed well.