Q: I read your column about ETFs. What I don't understand is what advantage ETFs have over regular no-load mutual funds. All of my investments are in no-load mutual funds, mostly index funds at Vanguard and Fidelity. Why should I pay a commission, even a small one, over getting the fund commission-free? Are ETFs and regular no-load funds the same? Wouldn't the commission on an ETF make that purchase more expensive than a no-load fund? Are the operating expenses the same? -- C.G., by e-mail

A: There is no reason for a no-load mutual fund investor who is happy with her portfolio to switch to exchange-traded funds. But there are circumstances where ETFs can be very useful. Several years ago, for instance, I chose to use a self-directed brokerage account window in my employer's 401(k) plan. This allowed me to escape the fund choices in the plan. It made it possible to build a low-cost portfolio based on inexpensive index funds and exchange-traded funds.

The purpose of my recent column and online calculator was to show that commissions can become a trivial expense for ETF investors as the size of their portfolio increases. It is also possible to buy an ETF and pay a commission and still have lower costs than a no-load index fund that invests in the same asset class.

Here's an example. The Vanguard 500 index fund has an expense ratio of 0.18 percent. The iShares S&P 500 exchange-traded fund (ticker: IVV) has an expense ratio of 0.09 percent. If your commission cost is $10, you'll have lower total expenses with the ETF once you invest at least $11,111. Vanguard 500 index fund Admiral shares have an expense ratio of 0.09 percent but have a minimum investment of $100,000. As a result, your expenses will be lower if you invest in the index fund up to $11,111. But the ETF will have a slight advantage between $11,111 and $100,000.

As a practical matter, most investors are likely to mix traditional index mutual funds and ETFs. At Fidelity, for instance, you can invest in Fidelity Spartan Total Market (ticker: FSTMX) and Fidelity Spartan Total International (ticker: FSIIX) at an annual cost of only 0.10 percent and have your core equity market investments. You could also invest in short-, intermediate- and long-term bond index funds that Fidelity has introduced in the last year.

You would have to look to ETFs, however, to get index investments for REITs, emerging markets, or domestic small-cap or large-cap value stocks.

You can compare expenses by using one of the online data sources such as www.morningstar.com or www.moneycentral.com. The online calculator is on my Web site, www.scottburns.com.

Q: What is your assessment of agency mortgage-backed securities (Ginnie Mae and Fannie Mae) as a retiree investment? I have $600,000 invested in these securities with yields of over 5 percent. I'm using these investments plus CDs to generate income. I also have a substantial investment in several stock funds that I'm allowing to grow untouched. They will be the source of my income in my later retirement years. -- M.W., Houston

A: These securities make very interesting vehicles for current income, particularly if purchased in a low-cost mutual fund. They are less interesting as individual securities due to their complexity, bid/ask spreads, and investor failure to understand that they don't perform the way most fixed income securities do.

The best thing about mortgage-backed securities is that they deliver long-term yields but tend to have much shorter maturities. The worst thing about them is that their maturity can get longer or shorter, but it will always move in the wrong direction.

Confused?

Let me explain. While the length and interest rate on a home mortgage is based on 30 years, most people sell their house or refinance it long before 30 years. As a practical matter, most mortgages last seven years or less. Unfortunately, if interest rates decline, a mortgage security investor won't benefit because the underlying mortgages will be refinanced.

So you'll never enjoy fat yields.

If interest rates rise, people do the opposite. Their low-rate mortgages become treasured possessions. That's when mortgage-backed securities decline in value. Investors can get higher yields elsewhere.

We can expect mortgage-backed securities to deliver somewhat higher yields than conventional bonds. Vanguard GNMA, the largest of the mortgage security funds, for instance, has provided a 12-month trailing yield of 5.01 percent, according to Morningstar. The average government bond fund provided a trailing 12-month yield of only 3.64 percent over the same period. That's a big difference.

Vanguard GNMA (ticker: VFIIX) has been in the top 10 percent of GNMA funds in the last 12 months, three years, five years, 10 years and 15 years. Its closest no-load competitors are Fidelity Ginnie Mae (ticker: FGMNX), Fidelity Mortgage Security Fund (ticker: FMSFX), T. Rowe Price GNMA (ticker: PRGMX) and USAA GNMA (ticker: USGNX).

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Personal finance writer Scott Burns is syndicated by Universal Press. His twice weekly column appears in newspapers from Boston to Seattle. He is the Chief Investment Strategist for AssetBuilder, Inc. Readers can register at www.scottburns.com. Questions/comments can be posted directly. They can also be sent, without registration, to scott@scottburns.com. Questions of general interest will be answered in future columns and on this blog.

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