In this article on our investment series, we will consider the advantages of ETFs and mutual funds. The duo gets a lot of attention due to their returns. Once you’ve discovered the benefits of ETFs and Mutual Funds for yourself, you are bound to give them a second look.
ETFs and Mutual Funds are two types of investment funds. An investment fund is a bundle of diversified securities that are offered to investors. It provides investors with the opportunity to invest in a wide range of options with a singular investment rather than investing in individual stocks, bonds, or commodities.
Like all other investment funds, ETFs and Mutual Funds provide diversification, low-cost entry, professional management, and accessibility. Before delving into the advantages of ETFs and Mutual Funds, we will first examine what they are.
Exchange-Traded Fund – ETFs
An exchange-traded fund (ETF) is a portfolio of diverse securities that tracks a specific index. The composition of the portfolio varies based on the underlying index. For instance, an emerging market ETF tracks stocks from companies in emerging market economies. Some ETFs track commodities; others track bonds and stocks.
ETFs have immense advantages over other investment finds. They offer lower operational costs, transparency, tax benefits, and flexibility.
A mutual fund is typically a bundle of stocks and bonds. Some mutual funds focus exclusively on either stocks or bonds, while others contain a combination of both.
The Advantages of ETFs and Mutual Funds
The following are some advantages of ETFs and mutual funds over investing in individual stocks:
The Low-Cost Entry Barrier
Investing in individual stocks can be capital intensive. Some stocks have share prices that run into hundreds of dollars. However, ETFs and mutual funds reduce the cost of investing. These investment funds create a bundle of securities and then offer shares of that bundle to investors.
Furthermore, investors do not require any expertise to invest in their desires sectors. The funds are managed by professionals (in mutual funds) and algorithms (ETFs). This reduces the knowledge base required for investing.
Another advantage of ETFs and Mutual Funds is diversification. Both investment funds offer investors to invest in virtually all public sectors. This gives an investor the opportunity to invest in any industry without the need for expertise in those areas. It also shields the investor from losing his funds to a single investment.
Mutual funds, by design, are risk-averse. The fund manager typically sticks with trusted and liquid securities. This limits most mutual funds to stocks and bonds; ETFs do not have such restrictions.
While ETFs are also risk-averse, they are opened to all major categories. If there is a market for it, there is likely going to be an ETF for it. Some ETFs trade on asset classes, commodities, and even currencies. ETFs trade in all major sectors, industries, and countries.
ETFs Versus Mutual Funds
Now that you know the advantages of ETFs and mutual funds, how do you make your choice?
Both of them offer diversified, low-cost investments. However, they have their differences. There are three critical metrics for deciding between ETFs and mutual funds.
Need for a Real-Time Update
Mutual funds provide real-time updates. The fund managers are required by law to send regular reports and statements to shareholders. These include monthly statements and tax reports. The downside to this is an increased overhead cost, passed on to the mutual funds’ shareholders.
ETF companies, on the other hand, are not responsible to the shareholders. Therefore, they are not required to share any report with customers. However, investors can get reports from the brokerage firm with whom they have an account.
Mutual funds can only be traded at the end of the business day. On the other hand, ETFs trade like stocks on stock exchange markets to be sold at any time.
For long-term investors, the opportunity to buy or sell at any time can leave them exposed to price swings. As such, they are likely to stick with mutual funds. Day traders make their profit from price volatility, so their preferred choice is usually ETFs.
Mutual funds are managed by professionals who observe the markets and make relevant decisions. The downside to this is the management fee. Furthermore, because most professionals are risk-averse, they stick with securities that have little price volatility. This translates into lower dividends.
ETFs, live by an index; the performance of the index affects the performance of the fund. This eliminates the need for a professional find manager. The downside is that the fund is overexposed to market events. A downward move in an index is sure to bring down an ETF as no one is in charge of the account.
The advantages of ETFs and Mutual Funds make them appealing to investors. Interested investors need to make their own research and risk assessment before engaging in any investment.