Charles Schwab, the discount brokerage, made a bit of news this week by offering eight new exchange-traded funds, or ETFs. That wasn't such a big deal in itself, since the ETF business is booming with new offerings from just about every mutual fund firm and brokerage. But Schwab has upped the ante by allowing its customers to trade the house-brand ETFs for free - without paying the $12.95 brokerage commission for trading other types of stocks.

Now that's interesting. Commissions have been one of the few drawbacks to ETFs, because they can chew up accounts of investors who want to add modest sums frequently. That $12.95 is 6.5 percent of a $200 purchase, for example. You wouldn't want to pay that every month. With an ordinary mutual fund, as opposed to an ETF, you can buy and sell with no fee if you deal directly with the fund company.

ETFs are a big deal. At the end of 1998 there were just 29 of them with a mere $16 billion in assets, according to the Investment Company Institute, the fund-industry trade group. At the end of last year there were 728 ETFs with $531 billion in assets. Growth has continued this year, raising assets to nearly $900 billion by the end of August, according to one tally. Mutual funds have nearly $9 trillion in assets.

So, with the landscape changing all the time, it's worth taking a moment to look at the pros and cons of ETFs versus funds. For just about every ETF there is a comparable index-style mutual fund, making the choice tricky.

Both represent pools of investor money used to buy specific types of securities, mainly stocks for ETFs. Most ETFs are index-style investments, meaning they automatically buy stocks contained in an underlying index, or market barometer, such as the Standard @ Poor's 500.

The chief difference is in the way each is bought and sold. ETFs are stocks, and are traded like stocks - through a broker, usually by paying a commission, at any time during the trading day based on a price that can fluctuate moment by moment. If you thought the day's Federal Reserve statement would push stocks up, you could buy an ETF in the morning and sell it in the afternoon. In fact, if you thought the statement would drive stocks down, you could do a short sale, selling borrowed shares in hopes of replacing them with ones bought cheaper, profiting on the difference. There is even options trading with some ETFs, allowing investors to make risky bets or insure against losses.

Mutual funds are dull by comparison. Put in an order anytime during the day and it will be filled at the end of the day at a price based on the closing values of the securities in the fund. There are no short sales and no options trading. Obviously, ETFs serve the needs of short-term speculators; funds don't.

Once an ETF is created and sold, it continues trading on the stock market, and the company that put it together has little contact with investors. If you want to get rid of your ETF, you just call your broker or make a few clicks of a mouse to sell it to someone else. With funds, it's quite different. The fund company takes your call when you want to buy, collects your money and uses it to buy more securities. When you want to sell, the company sells securities and sends you the money. All this is quite a bit of work, and it generally forces the fund company to charge a larger "expense ratio" than a comparable ETF charges. The Vanguard 500 Index Investor fund (VFINX) and the SPDR ETF (SPY) both mirror the moves of the S&P 500. But the fund's annual expense ratio is 0.16 percent of assets in the account, the ETF's is just 0.09 percent. Rock-bottom fees make ETFs appealing to long-term investors.

Mutual funds must sell stocks they hold to raise money for investor redemptions, and when those sales generate net profits for the year, the gains are paid out to investors, usually in November of December. These payments can trigger tax bills even if the money is automatically reinvested in more fund shares.

Since ETFs do not sell holdings to satisfy redemptions, they typically don't present the same problem of taxable distributions. Instead, gains are reflected in the ETF share price and you are taxed only after selling the shares. Morningstar Inc., the fund-tracking firm, has found that ETFs generally trigger smaller tax bills than comparable mutual funds, but not always. The Vanguard fund mentioned above has been more "tax efficient" than its ETF rival, mainly because Vanguard's managers use various techniques to keep taxes down. When selling a block of stock to meet shareholder redemptions, for example, they can sell the shares that had cost the most, minimizing the taxable gain. (You can investigate ETFs on the Morningstar Site.)

It all boils down to this: ETFs are preferable for short-term traders and speculators. Because their expense ratios are lower, they can also be better for long-term investors whose trades are large enough to make commissions insignificant. That generally requires using a discount broker charging less than $20 a trade. If you have a large sum to invest all at once, the ETF could be the best choice.

Mutual funds are better for ordinary investors putting in modest sums every month or quarter, since there are no commissions.

Of course this could change if many financial services firms follow Schwab's lead and offer commission-free trading on ETFs.

Jeff Brown is an experienced business journalist and personal finance columnist who has written for The Philadelphia Inquirer, The New York Times, and TheStreet.com. Read his bio to learn more about him.

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