As an investor contemplates his or her destination, one will have to weigh the potential benefits and drawbacks of utilizing an exchange traded fund or mutual fund investment vehicle.
For instance, many appreciate the ability to buy and sell ETFs, like a stock, at market price on an exchange throughout normal trading hours, something that is lacking in mutual funds, which price once per day after market closes, writes Kate Stalter for U.S. News.
However, while ETFs can be traded throughout the day, it does not mean investors should day-trade ETFs, especially when incorporating the funds into a long-term investment portfolio. When executing ETF trades, investors will incur trading fees, and the commission costs do add up when weaving in and out of the market.
Additionally, others may like the idea that they know what their ETF is holding on a daily basis, instead of waiting for the fund industry’s quarterly or twice-yearly holdings report, which may shift in the time the reports are issued. [When Switching to ETFs from Mutual Funds Makes Sense]
Rick Ferri, founder of investment management firm Portfolio Solutions, argues that an investor should start by outlining their investment philosophy before deciding on the delivery vehicle.
“When you go to buy a pair of shoes, you don’t care about the color of the shoebox,” Ferri said in the article. “You first have to decide what is it you’re trying to find for your portfolio. How it’s delivered to you is secondary.”
When it comes to ETFs and mutual funds, most investors typically weigh the benefits of low-cost passive indexing versus active management.
“Once you get past the idea of the exchange-traded features and doing your transacting at a market price rather than net asset value, you have to come back to your investment strategy,” Jim Rowley, senior investment analyst at Vanguard Investment Strategy Group, said in the article. “Do you want an indexing or an active strategy?”
Investors may notice that most ETFs are cheap because of their low maintenance – the funds passively reflect the performance of an underlying index. The average U.S.-listed ETF’s expense ratio is 0.61%, according to XTF data. On the other hand, active funds may have higher fees as they require a hands-on management team, and some funds tack on 12b-1 fees, which include marketing and operational expenses. [Build a Dirt-Cheap Portfolio With These ETFs]
Investors, though, should be aware that Vanguard Group’s line of ETFs are considered a separate share class of their index-based mutual funds, so Vanguard’s ETFs and mutual funds share the same low fees.
If an investor is seeking the expertise of active management, mutual funds provide a large range of options.
“If that’s what you want, you don’t have that many choices in ETFs, and you have thousands of choices in the mutual fund world,” Michael Iachini, managing director of mutual fund and ETF research for Charles Schwab Investment Advisory, said in the article. “The odds are good, if it’s an active strategy you are looking for, you can find it in a mutual fund. It might not even exist in an ETF framework, and certainly if there’s a specific manager you want, they’re probably not managing ETFs now.”
Nevertheless, the actively managed ETF space is growing, with 122 active U.S.-listed ETFs on the market and $18.3 billion in assets under management. More mutual fund providers are also looking into the space. For instance, the Securities and Exchange Commission recently approved Eaton Vance’s exchange traded managed fund structure. [SEC Approves NASDAQ to List Eaton Vance’s ETMFs]
For more information on investing in ETFs, visit our ETF 101 category.
Max Chen contributed to this article.