Index funds and exchange traded funds are constantly compared to one another because of their similarities. As investors started to notice that mutual funds usually underperform the intended benchmark, they decided it was time to invest in the benchmark.
“During the 1990s, the American love affair with funds began to stale. Investors started to compare the performance of their funds with appropriate benchmarks and noticed that most funds couldn’t keep up. For example, investors in a domestic equity fund would compare performance to the S&P 500 and more often than not, the S&P 500 performed better,” financial advisors Tom and John Mills wrote on Napa Valley Register. [Younger Investors are Biggest Users of ETFs]
Cost has become the biggest focus among investors and ETF sponsors of late. The race to slash fees and offer the highest quality product at the best price has become the way to gain market share. However, there is a long way to go before ETFs can gain more of the mutual fund market share. The following is a look at where ETFs can use improvement:
- A non-managed ETF is a good way to cut costs, but it does not give better performance. A passive, broad based ETF has great advantages such as diversification and liquidity but it does not mean returns are guaranteed. [2012 Was the Year of the Bond ETF]
- Costs are lower for ETFs, compared to mutual funds. Since ETFs trade with the ease of a single stock, active traders rake up brokerage costs and fees that add up.
- Active management does have a plus side – the ability to dodge risk and enhance performance. This can lead to tracking an index much better while still mitigating risk.
Both ETFs and mutual funds have strong points and weaknesses. It can be beneficial to understand and use both in an investment strategy rather than avoiding one or the other completely. [ETFs vs. Index Funds]
Tisha Guerrero contributed to this article.