Ladies – if your significant other tells you he’s been buying Diamonds, don’t get too excited. Chances are he’s talking about one of the fastest growing ETFs, not a girl’s best friend.

ETFs, or exchange-traded funds, are pools of money which typically are invested in the stocks or bonds that make up a well known index, such as, in the case of Diamonds, the Dow Jones Industrials.

ETFs are exploding in quantity and variety. Last year about $50 billion flowed into these funds, boosting investment in the sector to over $200 billion. Though still tiny compared to the $8 trillion invested in mutual funds, ETFs are gaining fast.

There are numerous kinds of ETFs available today, including those that track the major market indexes of domestic and foreign markets, as well as numerous sectors of the market, such as health care or energy. There are also fixed income ETFs, and one launched last year that invests in gold.

ETFs are so obviously the investment vehicle of choice that some market observers expect them to render obsolete stock research, mutual funds, and, probably, this column.

Why the excitement? ETFs are an inexpensive, simple and tax efficient way for an individual or an institution to quickly put money to work, and to diversify or hedge a portfolio.

Buying an ETF is as easy as buying a share of stock. They are traded on the major stock exchanges, and are highly liquid. Assuming you have a stock brokerage account, there is no additional paper work, no forms to sign, no muss, and no fuss. In other words – a lot easier than signing up for a mutual fund.

Also, they can be treated like any other stock. That is, they can be sold short (without an uptick rule), and bought on margin. Also, they can be redeemed at any point during the trading session – just like a stock.

The Diamonds referred to above are an ETF launched in 1998 by State Street, sponsor of Spiders, the first and still-largest ETF, which tracks the S&P 500.The Diamonds Trust Series I mimics the Dow Jones Industrial Average, and by the middle of last year had assets of $7.5 billion. It is traded on the AMEX under the symbol DIA, and trades on average more than 6 million shares each day.

And, the expense ratio is 0.18%. This compares to a typical mutual fund expense figure of 1.5%.That difference would be insignificant if fund managers had a proven ability to outperform the market averages – but they don’t.

Morningstar published a report revealing the percentage of managers between 1993 and 2003 that underperformed the indexes. It was not pretty. Specifically, 98% of value managers running portfolios of large capitalization stocks underperformed the market indexes on an after-tax basis. In most categories the numbers were similarly damning.

In fact, the only group that appears to have done better than the averages was small cap growth stock portfolios. Perhaps that feat speaks to the virtues of investing in stocks not heavily covered by Wall Street research. But that is a topic for another day.

Interestingly, the Morningstar study points out in high relief the tax benefits of ETFs. On a pretax basis, the managers were much more competitive with the indexes than on an after-tax basis. That’s in part because mutual funds are required to sell securities to raise cash when investors redeem their shares. Thus, they are often not able to trade stocks in a tax-efficient manner.

ETFs are structured so that no such sales are necessary. Most holders of ETFs end up the year with zero capital gains tax requirements, even if the fund has scored good gains during the year.

So, the investor makes the decision when to reap profits, and incur taxes – by when he sells his shares. The worst of all worlds is having lost money in a mutual fund, but having still incurred taxes through the trading that took place during the year. This cannot happen with an ETF.

There are numerous folks planning to launch new ETFs. In addition to more commodity ETFs and other sector vehicles, there’s talk of managed ETFs. Given the dismal history of managed funds, one wonders why.

Ms. Peek is a former managing director of Wertheim, now part of Citigroup.