Index investing has become increasingly popular over the last decade. One reason is that many actively managed mutual funds have failed to outperform consistently their respective benchmarks. The method of choice for index investing has traditionally been no-load mutual funds that invest in a particular index, such as the Standard & Poor's 500 index. However, a new way of index investing is capturing a growing part of the index market.

Increasingly popular investment vehicles for index investors are Exchange-Traded Funds (ETFs). An ETF is an investment in a particular stock index. For example, there are ETFs that invest in the stocks that comprise the Dow Jones Industrial Average, Standard & Poor's 500, and Nasdaq 100. You can also invest in ETFs that invest in certain industry sectors, such as technology.

ETFs are similar to no-load mutual funds in that both invest in the stocks that comprise a particular index. However, ETFs offer a few advantages relative to no-load mutual funds.

One advantage is that ETFs trade like stocks. (Many ETFs trade on the American Stock Exchange.) Thus, you can buy and sell ETFs intraday, unlike a no-load mutual fund, which conducts transactions for new investors only at the end of the day.

Another advantage is that, because you buy and sell ETFs at your discretion, you only incur a tax liability when you decide to sell your ETFs. Investors in no-load mutual funds are beholden to the fund manager when it comes to possible tax liabilities.

Since you buy ETFs like stocks, you will incur a brokerage commission when you buy and sell ETFs. This differs from no-load mutual funds, which don't charge a commission for transactions. Thus, when buying or selling ETFs, it is important to control your transaction costs. One way to control your transaction costs when buying ETFs is via BUYandHOLD (www.buyandhold.com). The transaction fee when buying or selling ETFs is just $2.99 per trade, regardless of the amount you're investing.

One last point about ETFs is worth mentioning. These vehicles can be extremely effective ways to diversify a stock portfolio with relatively small amounts of money. Indeed, a portfolio holding a few ETFs, especially ETFs that mimic a broad index (such as the S&P 500), and a few individual stocks can be surprisingly diversified. Thus, ETFs allow an investor to hold a fewer number of stocks (which simplifies portfolio record keeping and monitoring) while still being prudent from a portfolio diversification standpoint.