There is a rivalry that is forming in the investment world bigger than the Lakers vs the Celtics or the Yankees vs the Red Sox. It is the ETF vs the Mutual Fund. While many investors are familiar with Mutual Funds, they have little knowledge of Exchange Traded Funds. There is a difference in investment strategy, fees, and tax implications.
An Exchange Traded Fund (ETF) is a diversified collection of stocks and/or bonds that trades on the stock exchange. More diversification means less risk. Most ETFs are index funds which track market indexes and were created in order to replicate the performance of market indices, such as the S&P 500. This allows investors the opportunity to track the performance of the entire sector rather than just investing in single stocks.
ETFs are becoming the staple of portfolios because of lower fees, lower trading costs and expenses, and tax efficiency. When you add solid performance to that – investors get to keep more of what they earn. Why are ETFs compelling? Consider the following:
ETFs are structured differently than Mutual Funds according to the way they re-invest dividends and pay them out to shareholders, and that creates tax advantages and a shield against capital gains. ETFs are also more tax efficient because of the way they are redeemed, and because they are passively managed. An ETF will have less turnover inside the fund, creating less capital gain to be realized at end of the year. And, unlike Mutual Funds, ETFs do not have to sell off holdings to meet investor redemptions which also limits the possibility of paying capital gains, instead shareholders can be offered “in-kind redemptions.”
Broad based index ETFs have significant assets and a large daily trade volume which translates to liquidity. ETFs have greater transparency because holdings are disclosed on a daily basis. A mutual fund is only required to disclose holdings on a quarterly basis.
Flexibility within the trading process is important too – ETFs are continuously priced according to market value, and are redeemed in large lots by institutional investors with shares trading throughout the day like stocks. On the other hand Mutual Fund purchases and sales take place directly between the investors and the fund, and are only priced at the end of the trading day based on their Net Asset Value (NAV), or the value of fund assets minus liabilities divided by the number of shares.
ETFs often have lower minimum investments so you don’t need a fortune to jump into the market. ETFs are “passively” managed which keeps expenses and under-performance down, compared to “actively” managed mutual funds which constantly make trades trying to outsmart the market. They seldom do!
All of the above are the reasons why ETF ownership has been growing rapidly, while Mutual Fund ownership has fallen in the past 5 years. While many of the first ETFs simply tracked the major indexes, there is now a mind-boggling array of products and exotic ETFs like ”strategic beta funds,” so investors must choose wisely.
While there is a big rivalry between ETFs and Mutual Funds, keep in mind all investments have pros and cons. Everyone’s investment goals are unique – TFG’s 360 degree, “whole-istic” approach can help you reach yours! Feel free to contact me, Cory Lyon, directly at 561-209-1120, with any questions regarding financial investment strategies. At TFG, we believe in customized investment portfolio design and personalized asset management. I act as a fiduciary for all my clients.
TFG Financial Advisors, LLC is a registered investment advisor. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any securities, and past performance is not indicative of future results. Investments involve risk and are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed here.