Exchange traded funds have enjoyed solid inflows in recent years even as investors pull money from equity mutual funds after the subprime crisis. What are the major differences between these funds and when does it make the most sense to use one or the other?
“So the reason for the success of the ETF industry is that it serves the investor better. So the hallmark of ETFs is that every ETF ever launched is fully transparent with intraday liquidity and in many cases better tax efficiency. So it is in the enlightened self interest of all investors to be using more and more ETFs,” said Jonathon Steinberg, WisdomTree CEO, in a recent Morningstar interview. [Diversified ETFs vs. Sector Funds]
The most obvious factors in choosing an ETF or mutual fund investment rests upon management fees, shareholder transaction costs, and tax treatment. Overall, a passive long-term investor in some cases may benefit more from a mutual fund as a buy-and-hold investment. Institutional investors and traders may benefit more from the nimble nature of an ETF. [Five Things You Need to Know About Trading ETFs]
Here are a few comparisons:
- Advantages: Due to the flexible nature of ETFs, they may appeal more to the majority of investors. ETFs can trade throughout the day, same as a liquid, single stock. Traders like ETFs for the same reason passive investors do–broad diversification in one basket that is transparent and low cost. There are no contracts, rollover costs or margin with ETFs. Long term passive investors appreciate mutual funds for their ease of use. There is no brokerage account required to invest in one.
- Cost: ETFs generally have lower expense ratios and fees than active mutual funds, although ETFs can involve broker commissions to buy and sell.
- Taxes: ETFs are tax efficient due to the in-kind creation/redemption feature, which cuts down on capital gains distributions. ETFs also dodge capital gains by transferring out the stocks with the highest unrealized gains as part of the creation/redemption process. [ETF Flow Data May Not Tell Whole Story]
The differences between ETFs and mutual funds are plenty but the aforementioned can be deciding factors between which to invest in. Much of the decision is also based upon investment goals, needs and timeline for the particular investor. [ETF Model portfolios Should Come with More Education]
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.