Why are exchange-traded funds better than mutual funds?
Lower costs: Although it's not guaranteed, ETFs often have lower total expense ratios than competing mutual funds, for a simple reason: when you buy shares of a mutual fund directly from the mutual fund company, that company must handle a great deal of paperwork—recording who you are and where you live—and sending you ...
ETFs typically have lower expense ratios than mutual funds because they offer minimal shareholder services. Though mutual funds may be slightly more costly, fund managers provide support services.
Positive aspects of ETFs
The 4 most prominent advantages are trading flexibility, portfolio diversification and risk management, lower costs versus like mutual funds, and potential tax benefits.
ETFs give you an efficient way to diversify your portfolio, without having to select individual stocks or bonds. They cover most major asset classes and sectors, offering you a broad selection.
While ETFs provide liquidity, lower expense ratios, and tax efficiency, mutual funds offer active management and broader diversification. Understanding the differences between ETFs vs mutual funds is crucial for investors to align their investment strategies with their financial goals and risk tolerance levels.
Key Takeaways. Many mutual funds are actively managed while most ETFs are passive investments that track the performance of a particular index. ETFs can be more tax-efficient than actively managed funds due to their lower turnover and fewer transactions that produce capital gains.
For instance, some ETFs may come with fees, others might stray from the value of the underlying asset, ETFs are not always optimized for taxes, and of course — like any investment — ETFs also come with risk.
In terms of safety, neither the mutual fund nor the ETF is safer than the other due to its structure. Safety is determined by what the fund itself owns. Stocks are usually riskier than bonds, and corporate bonds come with somewhat more risk than U.S. government bonds.
The single biggest risk in ETFs is market risk.
ETFs can be a great investment for long-term investors and those with shorter-term time horizons. They can be especially valuable to beginning investors. That's because they won't require the time, effort, and experience needed to research individual stocks.
Is it safe to invest in exchange-traded funds?
ETFs can be safe investments if used correctly, offering diversification and flexibility. Indexed ETFs, tracking specific indexes like the S&P 500, are generally safe and tend to gain value over time. Leveraged ETFs can be used to amplify returns, but they can be riskier due to increased volatility.
The low investment threshold for most ETFs makes it easy for a beginner to implement a basic asset allocation strategy that matches their investment time horizon and risk tolerance. For example, young investors might be 100% invested in equity ETFs when they are in their 20s.
While they can be actively or passively managed by fund managers, most ETFs are passive investments pegged to the performance of a particular index. Mutual funds come in both active and indexed varieties, but most are actively managed. Active mutual funds are managed by fund managers.
Mutual funds are priced once a day at the net asset value and they're traded after market hours. ETFs are traded throughout the day on stock exchanges just as individual stocks are. ETFs often have lower expense ratios and are generally more tax-efficient due to their more passive nature.
SPY was launched in January 1993 and was the very first ETF listed in the U.S.10. Index investing pioneer Vanguard's S&P 500 Index Fund was the first index mutual fund for individual investors.
If you're paying fees for a fund with a high expense ratio or paying too much in taxes each year because of undesired capital gains distributions, switching to ETFs is likely the right choice. If your current investment is in an indexed mutual fund, you can usually find an ETF that accomplishes the same thing.
The administrative costs of managing ETFs are commonly lower than those for mutual funds. ETFs keep their administrative and operational expenses down through market-based trading. Because ETFs are bought and sold on the open market, the sale of shares from one investor to another does not affect the fund.
As passively managed portfolios, ETFs (and index funds) tend to realize fewer capital gains than actively managed mutual funds.
Low Liquidity
If an ETF is thinly traded, there can be problems getting out of the investment, depending on the size of your position relative to the average trading volume. The biggest sign of an illiquid investment is large spreads between the bid and the ask.
Leveraged ETF prices tend to decay over time, and triple leverage will tend to decay at a faster rate than 2x leverage. As a result, they can tend toward zero.
Has an ETF ever failed?
In fact, 47% of all such funds have closed down, compared with a closure rate of 28% for nonleveraged, noninverse ETFs. "Leveraged and inverse funds generally aren't meant to be held for longer than a day, and some types of leveraged and inverse ETFs tend to lose the majority of their value over time," Emily says.
Timing and Strategy: The timing of your investments and your investment strategy can affect returns. Buying at a high point in the market or having a suboptimal strategy can lead to losses. Fees and Costs: Trading fees and management fees associated with ETFs can eat into your returns, potentially leading to losses.
Since ETFs are traded on the stock exchange, they can be bought and sold at any time during market hours like a stock. This is known as 'real time pricing'. In contrast, mutual funds can be bought and redeemed only at the relevant NAV; the NAV is declared only once at the end of the day.
Under the Investment Company Act, private investment funds (e.g. hedge funds) are generally prohibited from acquiring more than 3% of an ETF's shares (the 3% Limit).
Vanguard S&P 500 ETF holds a Zacks ETF Rank of 2 (Buy), which is based on expected asset class return, expense ratio, and momentum, among other factors. Because of this, VOO is a great option for investors seeking exposure to the Style Box - Large Cap Blend segment of the market.
