ETFs and Mutual Funds

6 Reasons Why Exchange Traded Funds Are Better Than Mutual Funds

By Larry Holmes

Exchange traded funds (or ETFs) are better for most investors than mutual funds. The mutual fund industry has experienced tremendous growth over that last twenty-five years or so. But it's a new era now. It's the era of the ETF.

What are exchange traded funds? ETFs are similar to index mutual funds. Essentially, an ETF is a portfolio of securities that is intended to provide investment results that, before fees and expenses, generally correspond to the price and yield performance of the underlying benchmark index. ETFs trade on the stock exchanges. As such, they offer features of a mutual fund in a stock-like instrument.

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There are at least six important advantages that exchange traded funds have over mutual funds…
  1. ETFs, instead of pricing once a day after the market closes (like mutual funds), are traded throughout the day as if they were regular stocks.
  2. Since an ETF trades like a stock, it can be bought and sold (and shorted at any time during market hours.
  3. Investors can calculate the value of an ETF during the day because the composition of the underlying portfolio - normally a published index - doesn't change. For example, the value of the SPDR ETF (SPY) that tracks the S&P 500 index is calculated continuously throughout the day.
  4. An ETF can be exchanged for the underlying assets it represents with the issuing institution for a small fee. It means that ETFs will not trade at significant discounts or premiums to the value of the underlying assets of the fund. This is not true with closed-end mutual funds.
  5. Because they are not actively managed and have very little portfolio turnover, ETFs carry some nice tax advantages over mutual funds because they distribute relatively few capital gains.
  6. Most ETFs have very low management fees, especially compared to mutual funds. And the lower the expenses, the more money goes into the investor's pocket.

So exchange traded funds offer most of the advantages of mutual funds -- instant diversification and many to choose from -- without the major disadvantages.

The primary disadvantage of an ETF is that if you are making small transactions on a regular basis, you will pay a commission on each transaction -- just like you would by buying and selling a stock.

But, all in all, the advantages of an exchange traded fund far outweigh any disadvantages. I suggest that you use ETFs as an important part of your investment strategy.

Copyright 2005

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