When Is It Time to Switch to ETFs? | ETF Trends

Investors continue to enjoy the benefits of exchange traded funds (ETFs), as evidenced by the industry’s landmark $1 trillion mark, reached just as 2010 was winding down. If you’re still stuck in old-fashioned mutual funds, how do you know when it’s time to make the leap?

John Waggoner for USA Today reports that about half the investors in ETFs are institutional investors, who use ETFs to invest new money quickly or gain exposure to more exotic asset classes, such as currencies and commodities. [ETF Strategies: Something For Everyone.]

But what about regular, average Joe investors? You guys have been dumping mutual funds in greater numbers than ever.

If you’re one of those, we’ve got some tips for you. You may want to make the switch if:

  • You’re not content with quarterly updates concerning your holdings – mutual funds are required to report once a quarter, though some disclose more often.
  • Your mutual fund costs a lot more than a similarly-constructed ETF. On average, the typical actively managed mutual fund charges about 1.25%, while the average ETF charges 0.5%. Most mutual funds, on average, are more expensive than ETFs. Check first.
  • Your actively managed mutual fund is underperforming its benchmark. Passive ETFs track a benchmark – no one is trying to beat anything.
  • You want to buy and sell frequently. Mutual funds are designed with the buy-and-hold investor in mind. The expectation is that you’ll put your money in and leave it there; many funds charge early redemption fees. On the other hand, ETFs can be bought and sold anytime during market hours.
  • You want more tax efficiency. Mutual funds kick off capital gains whenever there’s a redemption, because the fund’s manager must sell shares to raise cash. Capital gains with ETFs are relatively rare. [6 Mistakes ETF Investors Should Avoid.]
  • You want control. If you’re managing your own portfolio, you may want to own ETFs. Their transparency, variety and liquidity make them ideal tools for fine-tuning portfolio exposure. Mutual funds are opaque, so you may not always know what you own.

Tisha Guerrero contributed to this article.

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.