With the explosion of Exchange Traded Funds (ETFs), one of the more frequent questions I get is whether ETFs are better than mutual funds.

The issue has been somewhat distorted by several large investment management firms and newsletters proclaiming that “we will never buy another mutual fund.”

I think that this is a little extreme, because there is a place for both in an investor’s portfolio. Sure, ETFs are a great tool, especially in view of the fact that many fund companies have given new meaning to the word “arrogance.” Short-term redemption fees and ridiculous trading restriction have rightfully led many in the direction of ETFs as the investment vehicle of choice.

However, while I use ETFs in my advisor practice as well, I usually limit myself to their use in those investment orientations that are more short-term by nature, such as sectors and countries.

Using my trend tracking methodology, I have found that mutual funds (no load) tend to perform better in the early part of a new up trend, such as we’ve seen after the market meltdown during May/June 2006. ETFs seem to lag a little, which is understandable. After all, they are broad indexes and as such they need their underlying securities to establish a direction first before they follow the trend.

New ETFs are being brought to the market almost daily. Should you buy them right away? That depends on if you are gambling or investing. I personally like to see at least 9 months of price data, so I can monitor where trend is headed before making a commitment.

OK, so I am somewhat biased because I run a fee-only advisory practice.

However, over the past 5 years, I have received hundreds of phone calls and e-mails from some of my 17,000 newsletter readers complaining about being misled by unscrupulous stock brokers, who were more interested in their financial well being than in their clients’.

Calling up a client and peddling a fund that will provide the salesperson with a great commission, but will do nothing for the investor, is simply unethical to say the least. It does remind me of the great commercial a few years ago with the now classic line “let’s put some lipstick on that pig.”

There are certainly a number of conscientious brokers in existence who have their clients’ best interest at heart despite being commission based; unfortunately, they are a minority.

To me, getting a client into an investment is only the first step. The second is to guide him along the way and make sure that his position is liquidated should market circumstances require that this is in his best interest.

An advisor can best represent this unbiased evaluation if he is fee based and not hungry trying to chase the next large commission checks.

One of my newsletter readers had an interesting question. He asked:

“One of the most commonly used and maybe the best advice is to look at the 1,3,5 year perfomance and the rating among peers. Then why don’t the funds at the bottom lose all potential new customers and all the owners sell? Are there some hidden factors?”

Well, the hidden factor is that most investors don’t necessarily care about 3 and 5-year performance numbers, and I don’t either. I look at far more recent data since the economy is constantly changing and different criteria apply now as opposed to 3 or 5 years ago.

The rating among peers is, well, overrated. If you look back 5 years, you would find yourself in the depth of the last bear market. Using the peer rating, would you then have selected a fund that, say, only lost 20% while the peers lost 23%?

I don’t think so. The idea is to avoid bear markets altogether and only move back into the market once an uptrend has been established. Then you can select funds that are in tune with market momentum and current economic conditions.