Let's get ready to rumble.

In one corner is the mutual fund, time-honored champion of small investors. In the other corner a fast-rising challenger, the exchange-traded fund.

They are fighting for your investor dollar. Some experts predict the ETF will ultimately win the long-term confrontation.

"In a year such as 2008 when returns are low or negative, every 50 basis points (half of a percentage point) make a difference," said Tom Anderson, head of ETF research at State Street Global Advisors, Boston. "Because ETF fees on average are dramatically lower than those of mutual funds, the difference is huge."

ETFs, which hold baskets of stocks or bonds as mutual funds do, replicate market indexes or sectors with the goal of low-cost diversification. They're traded on an exchange so you can buy and sell during market hours, unlike a mutual fund in which you trade shares at the end of the day. Although you must pay to trade ETFs, annual fees are generally lower than even index mutual funds.

"A number of value-oriented ETFs have done astoundingly better than active mutual fund value managers this year," said Ronald DeLegge, publisher and editor of ETFguide.com in San Diego. "While in theory the active manager can raise cash and protect capital, that hasn't been working out because some top value managers are performing badly."

DeLegge noted that while the SPDR Dow Jones Large Cap Value ETF (ELV) is down 14 percent this year, the actively managed Legg Mason Value Trust (LMVTX) is down 28 percent.

This has been a somewhat perverse year, with the top-performing mutual fund and ETF both bear-market funds that bet on the market going down. The mutual fund ProFunds UltraShort International (UXPIX) is up 42 percent this year. In ETFs, the UltraShort MSCI EAFE ProShares (EFU) is up 40 percent.

In some ways, comparing mutual funds to ETFs is apples to oranges.

There is a buyer for every ETF seller because they are traded on exchanges, so an ETF doesn't have to scramble to sell holdings to meet a rush of shareholder redemptions as mutual funds sometimes do. No minimum initial investment is required with an ETF and there are no penalties for redeeming shares. Dividends are paid in cash, rather than reinvested as in a mutual fund. And annual fees are lower.

An ETF strong point has been ability to quickly add specialties, being done from commodities to solar energy to foreign currencies.

Many investors still have no exposure to commodities, which is obtained most easily with ETFs, DeLegge said. Examples are iShares GSCI Commodity-Indexed Trust (GSG), up 15 percent this year, or PowerShares DB Commodity Index Tracking Fund (DBC), up 20 percent.

"If you're looking for active money management, ETFs in their current form aren't there yet," said Scott Burns, director of ETF analysis at Morningstar Inc. "But if you're looking to index or to allocate to a sector or to access commodities or other asset classes that were once hard to reach, ETFs can be a suitable investment." Continued...