Exchange traded funds, or ETFs are mixed investment tools that use the trading flexibility of individual stocks along with the diversification advantages of mutual funds. ETFs have features that make them attractive to investors looking for a cheaper method to enjoy wide exposure to certain sectors of the businesses. They are similar to mutual funds but are better due to various reasons.
ETFs are cheaper than mutual funds. ETFs have very low annual expenses, nearly 20 basis points or 0.2% less. As against this, actively managed mutual funds show average expenses exceeding 135 basis points (1.35%). This does not include the extra 2% - 5% as loads, 12(b)-1 marketing fees, transactions costs, and soft dollar expenses mutual funds, passed on to you but never informed, except in very fine print that nobody cares to read.
ETFs have a lower turnover than most mutual funds. As ETFs do not require active management and hold nearly a steady stream of stocks, there is hardly any portfolio turnover. On the other hand, many actively managed mutual funds churn their portfolio many times throughout the year, leading to recurring transaction fees on every purchase and sale.
ETFs have higher tax-efficiency than mutual funds. As against this, actively managed mutual funds, carry taxable short-term gains and distributions to shareholders. ETFs make you liable for taxable capital gains while selling. Moreover, the legal structure of ETFs provides for higher tax-efficiency as compared to the passively managed index mutual funds.
ETFs are more flexible than mutual funds. They can be purchased and sold through your broker without any conditions on the trading day, like a normal stock. This offers investors lot of flexibility as against mutual fund investors, who cannot carry out transactions during market hours.
ETFs let you tailor your portfolio than possible with passively managed mutual funds. There are more than 150 ETFs offered by various institutions. These ETFs concentrate on various types of market sectors, from bonds to technology. This allows investors to customize their choices to get a required portfolio balance, so that you can concentrate on specific sectors while avoiding others, based on the market conditions.
ETFs have higher cash efficiency than mutual funds. As ETFs don’t have to retain a cash position to meet redemptions, they can afford to invest the entire money in securities. This makes them better performer than a mutual fund whose portfolio is same but has higher cash position.
Lastly, ETFs have more advanced hedging options for experienced investors. As ETFs can be purchased on margin or sold short like a stock, they let advanced investors to use advanced hedging, market-neutral, and other optional investment strategies.
However exchange traded funds are not for all. As they can be traded on stock exchanges, you have to pay a brokerage commission when you carry out any transactions. So if you are contributing smaller amounts regularly to your investing account, you’ll have to pay high commissions.
Tags: Exchange Traded Funds, Invest