Why would you choose ETFs over mutual funds?
Consider an ETF if:
| ETFs | Mutual Funds | |
|---|---|---|
| Pricing | Determined by market | Net asset value (NAV) |
| Tax Efficiency | Usually tax efficient due to less turnover and fewer capital gains | Not as tax efficient due to more turnover and greater capital gains |
| Automatic Investing | Not available | Yes, for investments and withdrawals |
ETFs guarantee a higher return than mutual funds. b. You have more control and flexibility because you can trade ETFs anytime while the market is open.
ETFs offer advantages over stocks in two situations. First, when the return from stocks in the sector has a narrow dispersion around the mean, an ETF might be the best choice. Second, if you are unable to gain an advantage through knowledge of the company, an ETF is your best choice.
Mutual funds are priced once a day at the net asset value and they're traded after market hours. ETFs are traded throughout the day on stock exchanges just as individual stocks are. ETFs often have lower expense ratios and are generally more tax-efficient due to their more passive nature.
How are ETFs and mutual funds different? How are they managed? While they can be actively or passively managed by fund managers, most ETFs are passive investments pegged to the performance of a particular index. Mutual funds come in both active and indexed varieties, but most are actively managed.
Key Takeaways
Both can track indexes, but ETFs tend to be more cost-effective and liquid since they trade on exchanges like shares of stock. Mutual funds can offer active management and greater regulatory oversight at a higher cost and only allow transactions once daily.
Mutual funds are usually actively managed, although passively-managed index funds have become more popular. ETFs are usually passively managed and track a market index or sector sub-index. ETFs can be bought and sold just like stocks, while mutual funds can only be purchased at the end of each trading day.
Unlike an ETF's or a mutual fund's net asset value (NAV)—which is only calculated at the end of each trading day—an ETF's market price can be expected to change throughout the day. (A mutual fund doesn't have a market price because it isn't repriced throughout the day.)
ETFs can be less expensive to own than mutual funds. Plus, they trade continuously throughout exchange hours, and such flexibility may matter to certain investors. ETFs also can result in lower taxes from capital gains, since they're a passive security that tracks an index.
Why are most ETFs a cheaper option than stocks or mutual funds?
The administrative costs of managing ETFs are commonly lower than those for mutual funds. ETFs keep their administrative and operational expenses down through market-based trading. Because ETFs are bought and sold on the open market, the sale of shares from one investor to another does not affect the fund.
Disadvantages include high fees, tax inefficiency, poor trade execution, and the potential for management abuses.
For instance, some ETFs may come with fees, others might stray from the value of the underlying asset, ETFs are not always optimized for taxes, and of course — like any investment — ETFs also come with risk.
Should you invest in ETFs? Since ETFs offer built-in diversification and don't require large amounts of capital in order to invest in a range of stocks, they are a good way to get started. You can trade them like stocks while also enjoying a diversified portfolio.
Actively managed ETFs are rising in popularity, offering investors targeted exposure and tax efficient benefits in a volatile market. In addition to tax efficiency, investors are seeking active management in certain asset classes and strategies, such as fixed income and thematic investing.
Because of their wide array of holdings, ETFs provide the benefits of diversification, including lower risk and less volatility, which often makes a fund safer to own than an individual stock. An ETF's return depends on what it's invested in. An ETF's return is the weighted average of all its holdings.
In general, ETFs can be more risky than mutual funds because they are traded on stock exchanges. Their value can fluctuate throughout the day in response to market conditions. This means that if the market takes a dip, the value of your ETF could drop quickly, and you could experience significant losses.
At least once a year, funds must pass on any net gains they've realized. As a fund shareholder, you could be on the hook for taxes on gains even if you haven't sold any of your shares.
Usually, ETFs have much lower fees and higher daily liquidity compared to mutual fund shares. ETF can be used for purposes like Hedging, Equitizing Cash, and for Arbitrage. ETF shareholders get a small portion of the gained profits, i.e, the dividends paid and interest earned.
*ETFs typically have higher daily liquidity and lower fees than mutual fund shares, making them an attractive alternative for individual investors.
Are ETFs more tax-efficient than mutual funds?
Although similar to mutual funds, equity ETFs are generally more tax-efficient because they tend not to distribute a lot of capital gains.
Low Cost — An important advantage of mutual funds is their low cost. Due to huge economies of scale, mutual funds schemes have a low expense ratio. Expense ratio represents the annual fund operating expenses of a scheme, expressed as a percentage of the fund's daily net assets.
Should I invest in ETF for the long term? ETF investing could help you grow money in the long run, thanks to the compounding power. They typically have lower costs than other types of investments. These benefits help you grow money over time.
| Symbol | Name | 5-Year Return |
|---|---|---|
| XNTK | SPDR NYSE Technology ETF | 18.58% |
| UPRO | ProShares UltraPro S&P500 | 18.52% |
| PTF | Invesco Dorsey Wright Technology Momentum ETF | 18.33% |
| QQQ | Invesco QQQ Trust Series I | 18.27% |
ETFs have several advantages for investors considering this vehicle. The 4 most prominent advantages are trading flexibility, portfolio diversification and risk management, lower costs versus like mutual funds, and potential tax benefits.
