While mutual funds have had a long and successful run, exchange traded funds (ETFs) are encroaching upon territories that used to belong to mutual funds. Does this mean investors see ETFs as a better investment option?
An ETF is a basket of securities that represents a specific sector, region or specific index. ETFs are like mutual funds in that respect, but ETFs trade throughout the day like a stock. They are priced and traded continually, and they provide transparency, liquidity, and cost efficiency. (How Wall Street is using ETFs to lure back investors).
According to Mark Kennedy, there are five reasons to consider buying ETFs instead of mutual funds:
- Tax benefits. ETFs only incur capital gains taxes when they are sold. Mutual funds, on the other hand, incur capital gain taxes as shares within the fund are traded through the duration of the investment, even when you still own it.
- Ease. Buying and selling ETFs is done with a single transaction at the stated price. Mutual funds, however, have shares that are constantly being traded to reach a target price and target performance.
- Cost efficiency. Many mutual funds are actively traded and actively managed, thus leading to higher management fees. Most ETFs are passive, meaning there’s no manager for you to pay.
- Variety. The ETF industry is inundating investors with more and more trading themes. Investors are better able to track the performance of an index or achieve a financial goal with an ETF.
- Transferable. When switching managed portfolios to a different firm, some fund positions have to close out before a transfer takes place. Liquidation of mutual funds could increase risk, increase commissions and fees and incur capital gains taxes. But ETFs can be transferred without complications when switching investment firms – ETFs are considered a portable investment.
For more information on ETFs, visit our ETF 101 category.
Max Chen contributed to this article.