ETFs Vs. Mutual Funds: The Case for ETFs
Which makes a better investment: exchange-traded funds (ETFs) or mutual funds? An ETF is an individual security, just like a stock. But unlike a stock, an ETF represents the indexed value of a collection of assets. Its price changes constantly throughout the trading day and generally keeps close to the value of its index. By contrast, the price of mutual funds are calculated at the end of a trading day to reflect the new prices of the assets they contain.
There’s no clear-cut answer for every investor under all circumstances, but ETFs have distinct advantages that make them better than mutual funds in several important respects.
The Tax Benefits
The biggest advantage an ETF has over a mutual fund is taxation. Due to their construction, ETFs incur capital gains taxes only when you sell them. Mutual funds incur capital gains taxes as the shares within the fund are traded throughout the life of the investment. Favoring ETFs over mutual funds can lower your tax bill from your long-term investments.
Simplicity of ETFs
While opening an account or redeeming shares in a mutual fund isn't typically a terribly complicated process, it does take more effort than a simple trade. You have to call customer service, fill out some paperwork, and then wait a little while for the transaction to go through.
As well as being simplistic investments, ETFs are also more cost-effective than mutual funds. ETFs are often, though not always, passively managed, meaning they're set up to track the return of a particular benchmark. There's no asset selection process involved. Since mutual funds are often actively managed, they're generally subject to higher management fees.
It's understandable that fund managers need to charge for their time and expertise. But if you think you can get as good or better returns with passively managed ETFs, you'll find they're the lower-cost option.
With more and more ETFs being released all the time, investors have new options to target a specific trading strategy. Commodity ETFs, style ETFs, country ETFs, even inverse ETFs. There are so many types of ETFs for investors, closely tracking the performance of a certain index or achieving a specific financial goal may be more easily attainable than with mutual funds, though it should be noted there are many different kinds of those as well.
Transferability of ETFs
Whenever an investor moves a managed portfolio to a different investment firm, complications can arise with mutual funds. Oftentimes the fund positions have to be closed out before a transfer can take place. That can be a major headache for investors, who are forced to make unwanted or untimely trades that could result in losses.
With ETFs, the transfer is clean and simple when switching investment firms. They are considered a portable investment, which offers a nice advantage over mutual funds.
Conducting Due Diligence
As with any investment, you should thoroughly research any ETF before committing your money to it. Conduct your due diligence, including monitoring how the fund performs under different market conditions and taking a look at the assets held in the funds. If you have any questions or concerns, make sure you consult a financial advisor or another financial industry professional.
The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.