Exchange-Traded Funds versus Mutual Funds
Part 1 of 2
YOU have two options to diversify your stock portfolio: exchange-traded funds (ETFs) and mutual funds. Both involve pooling money that becomes part of a big fund invested in a mix of different assets. Depending upon the mutual fund or ETF you buy, you can gain exposure to a broad mix of different assets with just a single fund purchase, making it easy to diversify and reducing risk compared with purchasing shares in a single company. While ETFs and mutual funds have a lot in common, there are important differences between them that you should understand when you decide which investment is right for you. Here are tips in choosing between ETFs and mutual funds:
ETFs Offer More Trading Flexibility:
ETFs are traded like stocks. They’re priced based on what investors think the market value is and you can buy and sell shares throughout the day. Mutual funds, however, can only be purchased or sold at the end of the trading day after the market closes and their price is based on Net Asset Value (NAV), the value of fund assets minus liabilities divided by the number of shares.
ETFs Provide More Transparency:
ETFs typically disclose holdings daily. Actively managed mutual funds typically disclose their holdings on a quarterly or semi-annual basis.
ETFs Are More Tax Efficient Than Mutual Funds:
Both ETFs and mutual funds are treated the same by the IRS in that investors pay capital gains taxes and taxes on dividend income. However, there are generally fewer taxable events in ETFs, which means tax liability will typically be lower. There are fewer taxable events because while mutual funds often must sell securities when shares are redeemed, ETFs are simply traded between investors and no underlying assets must be sold just because shares of the ETF are sold.
ETFs Often Have Lower Fees And Expenses:
ETF expense ratios are typically lower than mutual fund fees. In 2016, the average expense ratio of index ETFs was just 0.23% compared with a 0.82% average expense ratio of actively managed mutual funds and a 0.27% expense ratio for index equity mutual funds. Many mutual funds include a variety of fees in their expense ratio, including fees to cover marketing and distribution costs.
ETFs Often Require Lower Minimum Investments:
ETFs don’t require you to invest a lot of money at once. Many mutual funds have high initial investment requirements. This makes it a challenge to get started investing in a mutual fund if you don’t have a lot of money saved. ETFs allow you to buy as little as a single share, which means that you don’t need a fortune to get in the market. Try it.
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Victor Santos Sy graduated Cum Laude from UE with a BBA and from Indiana State University with an MBA. Vic worked with SyCip, Gorres, Velayo (SGV – Andersen Consulting) and Ernst & Young before establishing Sy Accountancy Corporation in Pasadena, California.
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He has 50 years of experience in defending taxpayers audited by the IRS, FTB, EDD, BOE and other governmental agencies. He is publishing a book on his expertise – “HOW TO AVOID OR SURVIVE IRS AUDITS.” Our readers may inquire about the book or email tax questions at [email protected].