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Since its invention in 1924, the mutual fund has been heralded as the “everyman’s investment.” But even if you read a fund prospectus, you can never be sure exactly how much you’re paying, what’s in the fund, or when you might incur a taxable distribution.
Ensuring that your portfolio is building wealth rather than lining some fund manager’s pocket is a major source of IRS: investment-related stress. That’s why you should consider exchange-traded funds (ETFs), a cheaper, more transparent class of investments that has attracted more than $300 billion in assets, up from half that amount in 2003.

Ways to play ETF

LAUNCH A SATELLITE
Place 70 to 80 percent of your portfolio in index ETFs and allocate your remaining assets to higher-cost, actively managed mutual funds. This “core and satellite” strategy enables you to spend your money on fund managers who have an information edge in niche markets—and are thus more likely to beat their benchmarks. Sample satellite sectors: U.S. microcap or emerging market stocks.

HEDGE OVER-CONCENTRATION
If you own a large, single-stock position—for example, oil shares—and can’t sell any to diversify, you’ll be hosed if the sector tanks. But you can hedge the risk by using ETFs to easily and cheaply build sector diversification around your holding. If you’re a sophisticated investor, you can also “sell short” shares of Energy Select Sector SPDR (XLE) by selling borrowed shares. If the oil sector drops, you buy them back for less, return them, and pocket the difference. This gain would hedge the decline in your core oil-stock holding.

DEFUSE INFLATION
Hard assets are often the antidote, and ETFs are a smart way to tap them as easily as buying stocks. Check out streetTRACKS Gold Trust (GLD), iShares Cohen & Steers Realty Majors Index Fund (ICF), iShares Dow Jones U.S. Basic Materials Sector Index Fund (IYM), and DB Commodity Index Tracking Fund (DBC), which provides exposure to futures contracts on crude oil, heating oil, gold, aluminum, corn, and wheat.