Although index funds might be a better instrument than the actively managed mutual fund, some investors may still be better off looking at exchange traded funds (ETFs). But how do you make the choice?
One of the biggest benefits of ETFs is that they boast lower expense ratios, saving you money. Although trading commissions were once a factor, many brokerages are lowering or eliminating them on some ETFs altogether.
Free Business Online explains that the advent of commission-free trades has removed what has once been one of the chief drawbacks of investing in ETFs relative to traditional mutual funds, particularly for dollar-cost averagers. [ETFs: More Than Mutual Fund Alternatives.]
Cost is one of the main factors in investing and choosing which tool to use to access the desired sector or asset class. Some ETF purveyors have calculators that can determine the impact of bid-ask spreads along with transaction costs and expense ratios, taking some of the guesswork out. Over a period of time, a few percentage points difference between a mutual fund and an ETF can add up to a lot of money.
Also, if the index fund’s net asset value is currently higher than your cost basis, you’ll owe capital gains tax when you sell, and you may not save enough over the life of your ETF investment to make up for the tax hit. ETFs generally do not have capital gains.
Mutual funds are also priced once a day, while ETFs are priced all day allowing for intraday trading. Most of the time, ETFs trade right in line with their NAVs and stray only when there is severe market volatility. [Mutual Funds, Step Aside.]
Also, ETFs are much more tax-efficient than mutual funds, however, ETFs can keep taxes more at bay when it comes time to add up the costs. Passive management, trading on secondary markets and in-kind redemption by authorized participants are ways that ETFs have beat mutual funds. [5 Things to Know About ETFs and Taxes.]
For more stories about mutual funds, visit our mutual fund category.
Tisha Guerrero contributed to this article.