Change is not necessarily a bad thing, but it can be a jarring thing for your clients – especially when they’ve been used to the mutual fund model that’s been around for decades. Many of them may not even be aware of how the mutual fund industry has been doing investors a disservice.
If you’ve made the decision to move your practice from mutual funds to ETFs, you’ll need to have “the talk” with your clients to get them comfortable with the idea. You will need to explain what ETFs are, why the mutual fund model is broken and, most importantly, what’s in it for them.
Fortunately, the pros of ETFs are so strong that you shouldn’t have a hard time making the case.
Mutual Fund: Cons
Before you discuss ETFs, it helps first to look at mutual funds – what they are, their limitations and why they no longer work for your clients or your practice. Some of the primary points you may want to bring up:
- Redemption Fee. Also recognized as an “exit fee,” “back-end load” or “contingent deferred sales charge,” these fees are collected by investment companies from traders as a way to discourage short-term, quick moving trades of mutual fund shares. Mutual fund timing is legal but usually tends to produce a negative effect on long-term investors. The sales charge or commission charge is placed on an investor when he or she is redeeming shares in a mutual fund.
- Investment Minimums. Mutual funds tend to have a required minimum dollar or share quantity for a purchased investment. Sometimes, this amount can be quite hefty.
- Higher Annual Fees. Most mutual funds are actively managed, so a large portion of the money investors have in these funds is going toward paying this manager. These expenses can be as high as 10%.
- Lower Liquidity. Mutual funds trade only trade once a day, at the end of the day. If you want to sell, you must wait until then.
- Capital Gains. When an investor sells a mutual fund, the mutual fund sells shares held within the fund to meet this redemption, which results in capital gains for all of the shareholders.
- Rebalancing. Mutual funds incur costs when holding cash to deal with the daily net redemptions.
Exchange Traded Fund: Pros
Getting your clients comfortable with the idea of ETFs shouldn’t be a challenging task once you clearly illustrate the cost savings, tax efficiency and flexibility that they offer. Some of the best features of ETFs you will want to point out to clients include:
- Tradability. ETFs trade throughout the trading day, like a stock, on an exchange. The ability to trade during normal trading hours allows for greater purchasing/selling price control. Furthermore, you may set protective features on trades, like stop-loss limits.
- Expense Ratio. As a result of the passive nature of most ETF strategies, internal expenses of most ETFs are usually lower than those of mutual funds. Some ETFs have expense ratios of as low as .06%, but ratios are typically between 0.30% to 0.95%. That’s compared to the mutual fund average of about 1.5%.
- Lower Costs. ETFs do not need to sell stock to meet redemptions, which means that capital gains are rare in ETFs. Additionally, ETFs do no include broker loads, which weigh down mutual funds with higher fees. There are commissions on trades, but there are price wars going on that can keep these costs down.
- Transparency. Fund providers include greater disclosure on their ETF products. Information on an ETF’s portfolio may be found on the fund providers’ website, along with prospectus sheets that display all the pertinent information what you are buying into. Clients who want more information can readily access it. Mutual funds only have to report their holdings quarterly.
- No Minimums. Like stocks, ETFs don’t require minimum dollar or share quantities to be purchased, except the listing price of a single share of ETF.
Once you’ve clearly laid out the differences and have demonstrated how ETFs are simply a better fit for your clients’ portfolios, you shouldn’t have any trouble getting them on board.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.