Posts Tagged: ‘Exchange Traded Funds’

Exchange Traded Funds vs. Mutual Funds

June 9, 2014 Posted by admin

Exchange Traded Funds (ETF) are one of the fastest-growing and most powerful investment tools, since their debute in the US Market in 1993. ETFs play an important role in the US investment revolution that began in 1924, when the first Mutual Fund was introduced to the investment marketplace. Like Mutual Funds, ETFs are well-diversified baskets of securities, which provide investors with a broader exposure to particular investment styles across particular industries with just a single investment. However, before investing in ETFs, it is very important to understand how they work and what makes them so attractive and different from Mutual Funds (MFs).

Actively Managed Funds

Each mutual fund hires a manager, who not only makes all the choices regarding the stocks within the investment basket, but also takes care of investors’ needs. When you decide to invest your money in the fund, fund’s manager has to create new shares to meet your purchases, and to sell existing shares to meet your redemptions. Most funds charge you one-time fees such as a front-end load (up to 8.5 percent) and a back-end load (up to 6.0 percent) to enter and exit the fund, as well as ongoing 12b-1 operating fees (up to 1.0 percent). Currently, the average annual expense ratio for traditional funds is 1.67 percent.

Passively Managed Funds

One of the main reasons for the popularity and high competitiveness of an ETF in the investment landscape is its lower fees. Unlike traditional funds, ETFs has no front-end and back-end loads. An ETF is a passively managed, low cost alternative to Mutual Funds. There is a predetermined set of rules that are used by the fund’s sponsor to govern the stock selection. An ETF is traded on a stock exchange. The investor only has to pay a trading commission to the brokerage firm through which the transaction is executed. Nowadays, the increased competition among brokers has significantly lower the cost of trading ETF shares. However, each ETF pays a sponsor an average fee of 0.27 percent to run the fund, which slightly reduces the return on investments, but is still much lower than the average annual fees a Mutual Fund faces.

The Negative Aspects of ETFs

The information above is thoroughly in favor of ETFs. ETFs have many advantages and just a few disadvantages over traditional Mutual Funds. The advantages mainly range from low investment cost to increased trading flexibility and investment transparency. However, being a prospective investor, you should not overlook the whole picture. The fact is that no-load Mutual Funds exist and they charge you only 12b-1 operating fees, ranging between 0.2 and 1.0 percent. This means that it is very likely in some cases your transaction costs to be greater with an ETF than with no-load Mutual Funds bought directly from the fund company. Another drawback that can arise is that ETF share prices are subject to supply and demand shifters. This creates a risky trading environment that is nonexistent with Mutual Funds. As a result, when investing in ETFs, share prices can differ slightly from the market value of the fund’s underlying holdings. Exactly like any other shares of stock traded on the stock exchange, the price a buyer pays is usually higher than the price a seller receives.