A major selling point of exchange traded funds is their low cost compared to mutual funds. The tax advantages of ETFs also contribute to overall savings over the long term.
“Experts have often panned the majority of traditional mutual fund offerings, pointing out that they can be expensive, illiquid and relatively inefficient when it comes to taxation. A new breed of funds, however, arose in the early 1990s and still provides many of the same advantages of traditional funds without several of these drawbacks,” Mark Cussen wrote for Investopedia. [BlackRock CEO Sees ‘Secular Shift’ into Index ETFs]
“ETFs are soon expected to surpass a record $2 trillion in global assets. Last year marked an all-time high for the industry on the eve of its 20th anniversary, with a $292.7 billion, or 28% rise, in U.S. ETF assets and positive cash flows of $182.6 billion,” according to State Street Global Advisors. [A Deeper Look at the ETF Fee War]
Capital preservation is a goal of most investors as the low yield market has made it difficult for investors to earn income on investments. The low cost of ETFs has attracted inflows over the past few years. Most traditional mutual funds cost an average of 1.50%, which adds up year after year. The ongoing 12b-1 fees that mutual funds soemtimes charge can equal up to an extra 1% of capital per year. The average cost of an ETF is around 0.45%. [Don’t Get Blindsided by ETF Capital Gains Taxes]
Since a mutual fund is run by a stock-picking manager, there are management fees. Since most ETFs are passively tracking an index, overhead is not a factor. The only cost consideration of ETFs is the brokerage fees. If an investor is actively trading, every time a trade is made, a fee is charged, similar to a single stock. However, some online brokers let investors trade certain ETFs commission-free.
Another consideration are capital gains distributions. All shareholders in a mutual fund can be hit with these costs whenever another shareholder sells out. Most broad-based ETFs have low portfolio turnover, which helps keep the tax bite low. Also, the “in-kind” creation and redemption feature of ETFs makes them tax efficient.
ETFs are a great investment for budget-conscious investors due to the lower costs and overall flexibility. Over time, the capital saved on fees and capital gains taxes will add up and help investors reach their financial goals.
Tisha Guerrero contributed to this article.