Exchange traded funds or ETFs have been around for twenty five years now. The very first ETF was introduced by State Street Global Advisor in 1992 which is still one of the most popular exchange traded funds these days. ETFs track a range of bond, commodity, currency, and stock indices. Some funds also track the performance of a board index, such as FTSE 100 while others are more focused on a specific area, company size or even a region or a country.
With low-cost index fund feature, exchange traded funds are listed and traded on all major stock exchange markets. Like money market mutual funds, these funds are made of securities and have their own ticker symbol. You can easily sell and purchase an exchange trade fund through your local or discounted online broker against a payable brokerage commission for selling and purchasing the fund.
Exchange traded funds are increasingly popular investment tool among individual and organizational investors, traders and other monetary professionals. Unlike mutual fund managers who seek to beat a standard index every year, they aim to reflect it. Most fund managers seek to underperform the market averages and rarely sustain their best returns over time. However, seeking to outperform the market after fees is not only difficult but also nearly impossible to acquire.
Most investors prefer purchasing an index exchange traded fund which is not only low cost but also can outperform most active manager in the market. As an investor, one of the most important decisions for you would be choosing right allocation for your investment portfolio. ETFs fit here perfectly as they allow you to easily adjust your asset allocation as the market and associated risks change so you can increase or cut exposures without a delay.
As the name suggests, these funds trade on exchanges, you can avail the advantages of similar trade types for both long and short term basis. Likewise, there are several ETFs that come with capability of puts & calls options to be written against them. These funds can also be purchased on specific margins. Most importantly, there is no minimum requirement of investment thus you can purchase as many or as little as you want. The best part is that diversification of most exchange traded funds plays very important role in reducing investment risks hence they are less volatile than stocks.
Expense Ratio with Exchange Traded Funds
Like other investment options, such as money market funds, ETFs has some costs to pay at the time of purchasing and selling a fund. Moreover, there is a standard brokerage commission which is payable to the broker whether you want to sell your fund or invest in a new fund. When compared to mutual funds, ETF have significantly lower costs ratio. For instance, annual management fees of mutual funds range from 1 to 3 percent while the same for ETFs go up to 0.2 to 1 percent. Likewise, mutual funds cost you between 0 to 5 percent on the purchase while with ETFs you just pay standard brokerage commission. However, the expense ratio varies from ETF to ETF depending on its type, so it is crucial to check with the fund prospectus before you invest in them.
Tax Benefits of Exchange Traded Funds
Most investors often overlook the higher amount of taxable monetary transactions which come with most mutual funds. Since mutual funds are actively managed, receiving high turnover, trading more in them leads to added taxation. The investor receives their returns after the tax and other costs are deducted from their fund even when they are not selling their shares. All this comes with a huge deduction in the fund’s income which is somehow disappointing. On the contrary, exchange traded funds comprise several benefits including those related to taxations. They aim to track benchmark indices and make smaller amount of trades. As a result, the low turnover of the portfolio leads to reduced frequency of tax gain supplies.
Whenever a mutual fund receives an investment profit which is not well-adjusted by a realized loss, the fund must allot its profits to its shareholders. These profits are subject to tax deductions even if you are reinvesting the distributions in further shares of a mutual fund. The investors of Exchange traded funds only realize capital profit when they sell their ETFs shares. The same goes true when the fund changes assets in its core index or when stocks are taken out from and included in the index. Therefore, it is better not to look at the reported pre-tax yields of an actively managed fund; instead, compare after-tax gains of available investments prior choosing where to invest your money.
Why Choosing ETFs over Mutual Funds
The variety of exchange traded funds on varied exchanges has dramatically introduced a new era of investments for active investors of bond, stock and money markets. On the whole, these funds have garnered top volume on all the key exchanges and are very active trading instruments. Furthermore, they are exempted from several provisions of 1940’s Investment Act which oversees mutual funds and inhibits many provisions in their performance. Exchange traded funds offer simple diversification and more tax-efficient benefits than mutual fund type investments. They are setup through an intricate process and supplies shares depending on creation units. Generally, ETFs are meant to imitate the cost action of index S&P500 or other similar index types.
In addition, ETFs are very flexible in purchase as they have no minimum purchasing requirements. For that reason, you can buy and sell these funds through numerous orders, such as limit orders, stop limit orders, and GTC. When it comes to trading funds, ETFs are very similar to bonds, stocks and futures. Moreover, they come with higher level of transparency while a recent development also allows them to be actively managed like mutual funds. Above all, there is no contest for those investors who want to trade in shorter term as you can simply sell ETFs in the market and get huge peace of mind. In conclusion, exchange traded funds make a better investment option than mutual funds for many reasons.