The mutual fund industry has taken its licks in the last year. So while investors await a firm economic recovery, it’s time to examine why exchange traded funds (ETFs) may be a better alternative if you’re looking for somewhere to go.
Mutual funds are sorely lacking in a few areas, and as investors become more informed, they’re going to begin demanding things that they often don’t offer, such as full transparency, intraday trading and low fees. Ron DeLegge for ETF Guide has five reasons why it might be time to sell your mutual fund if you own one, then we make the case for ETFs as an alternative:
1. Regular Market Underperformance. If you own a stock or mutual fund that is consistently underperforming its index or market cycles, it is a sure sign it’s time to get out. One economist suggests comparing a fund’s return with a comparable passive alternative to see how the performance stacks up.
2. Fee Increases. Rising fees take a greater portion of both your returns and income, so is there much more to say? Low-cost competition should abound, and ETFs already offer this. While fees might seem like small numbers, they really add up over years and years.
3. Manager Changes. If investment objectives and managers keep changing, it is a sure sign to get out, since these shifts can be disruptive. DeLegge notes that if you plan on owning a fund for 30 years, you’re likely to have five or six different managers. Most ETFs don’t have active managers.
4. Changing Policies. Often, the changes are not announced by the fund company, but can be uncovered by evaluating your mutual fund’s holdings. ETFs, on the other hand, are transparent, so nay changes to holdings are evident as they happen.
5. Radical Make-Over. If a mutual fund company changes its name, or a fund merges with another, or providers merge, these are not good signs. They are usually a distress signal and it is frequently counterproductive to the performance of your fund.
When you think about all these things, they sure make ETFs sound appealing, don’t they? Here are five things that make ETFs superior:
1. Transparency. When you buy an ETF, you always know what you own. The holdings of any given ETF are easy to locate and are posted daily. There are no secrets or surprises here.
2. Diversification. ETFs are a basket of stocks – rather than having to rely on guessing about which company is going to be the winner in a given industry, you can just buy a fund that represents the entire sector and spread the risk around a little.
3. Ease of Use. Information about ETFs, their expenses, their holdings, their weightings and charting is easily and readily available, as well as simple to understand. This doesn’t mean that using ETFs doesn’t involve some education, but this education is easy to acquire.
4. Inexpensive. Not all ETFs are dirt-cheap, but on the average, the fees are lower. That’s because typical ETFs lack an active manager. However, some actively managed ETFs are coming in cheaper than their mutual fund counterparts.
5. Tax-Efficiency. Capital gains payouts are rare, and since ETFs don’t sell their holdings to meet redemptions, other capital gains issues are avoided.
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