The exchange traded fund industry has grown at a rapid pace since the first U.S. fund started trading in 1993. A majority of investors have been slow to warm up to ETFs, however, below are several convincing reasons to use them.
“The vast majority of ETFs were created to track sectors of financial markets. So using them means you are betting on specific parts of the market, and expect to earn whatever average returns those sectors generate — or suffer whatever losses they incur,” Tom Petruno wrote for The LA Times.
Below are a few highlights of using ETFs:
ETFs have a purpose for both long-term investors and short-term traders. Their structure allows them to be useful to a buy-and-hold portfolio, but those who want to move nimbly in and out of positions can utilize ETFs since they can trade with the ease of a single stock.
ETFs are also useful for tactical investing. They give investors the ability to invest in a corner of the market, or to bet on a large swath of a market. For example, if an investor wants to bet on the debt in emerging economies, there is the WisdomTree Emerging Markets Local Debt (NYSEArca: ELD). [Mutual Fund Companies Readying ETFs]
Petruno reports that tax efficiency is a huge selling point for ETFs. Due to the way the funds are constructed, taxable capital gains are not issued to shareholders. Portfolio gains are factored into the share price of an ETF, so investors make gains when they sell, not when every other shareholder does. If a portfolio is created outside of a tax sheltered account, this can be important. Traditional mutual funds are required to pay out any net realized capital gains to all shareholders. [Low Fees Support the Push for All-ETF 401(k) Plans]
Lastly, ETFs tend to be lower in cost than their mutual fund counterparts. However, investors who trade frequently must consider that ETFs do have commission expenses, so every transaction counts, similar to a single stock. These commissions are in addition to the expense ratios. Most of the broad-based, U.S. stock funds such as the Vanguard Total Stock Market ETF (NYSEArca: VTI), with an expense ratio of 0.07%, are a cheaper alternative to a similar mutual fund. For investors who continually contribute to a 401(k) plan, however, mutual funds may still the best choice since there are no commissions charged. [Morningstar’s Model ETF Portfolio for Younger Investors]
Tisha Guerrero contributed to this article.