It’s true that ETFs and mutual funds are often called “sister” investments because of their similarities. But investments in ETFs have been growing at an accelerated pace while mutual funds are just recovering from major outflows during the peak years of the recent financial crisis. We believe that certain key differences make ETFs the preferred choice for many investors today. Here are seven reasons why.
ETFs trade just like stocks
ETFs are traded on the major stock exchanges with share prices that fluctuate the same as any stock. Limit orders can be used to control/execute trades, and put and call option trades are available. Not so for mutual funds, whose share price is calculated once each day at close of market. No limit orders, no option trades allowed.
ETFs fully disclose portfolio holdings every day
Compare that to monthly or quarterly disclosure of portfolio holdings for mutual funds.
ETFs are more accessible to investors
ETFs can be purchased in any brokerage account whereas mutual funds’ availability depends on distribution agreements with brokers/dealers (in some cases, they may be purchased from fund sponsors directly).
ETFs are generally less expensive to trade*
As client services are generally handled by the broker, ETF expense ratios are most often lower than those of mutual funds whose sponsors must incur all the administrative and distribution fees.
ETFs are typically more tax-efficient
ETFs can conduct in-kind redemptions and avoid actually selling holdings that trigger capital gains, which can reduce tax liability for investors. Mutual funds’ ability to manage tax liability is largely limited by the cash requirements to create shares.
ETFs can be traded on margin
Just like stocks, ETFs can be bought and sold on margin, allowing investors to benefit from leverage. Margin trades are not allowed for mutual funds.
ETFs have lower minimum investment thresholds
“Beginner” investors can actually buy single shares of ETFs. Most mutual funds restrict entry purchase to minimums that range from $1,000 to $2,500 (although for IRA accounts, those minimums are usually reduced).
* ETFs are subject to commission costs each time a buy or sell is executed. Depending on the amount of trading activity, the low costs of ETFs may be outweighed by commissions and related trading costs compared to mutual funds.