Just when many people have started to understand what a mutual fund is, along comes something new. That something new is the Exchange-Traded Fund or ETF.
ETFs are the fastest growing of all the investment tools. If you are working with an advisor who is compensated solely on sales loads, you may not be aware of them, since there are no sales fees, or multiple classes with ETFs.
Following are some of the advantages ETFs generally have over mutual funds.
- Lower internal fees. ETFs don’t have to share internal fees with large trading outfits like mutual funds do, so typically they have lower internal fees. Also, as I just mentioned, only one type of share class is produced per fund, and it has no load.
- Have you ever been told by your CPA that you owe capital gains tax on a mutual fund you didn’t even sell? Most investors have been told this unhappy news. When you invest in a mutual fund, you often purchase the gains from the person who owned the mutual fund before you.. This is usually not the case with ETFs. Also, as you hold a mutual fund over the years, you may be paying taxes on year-end capital gain distributions year after year. This can create a very complex tax recordkeeping situation.
- Intraday trading. If you want to sell your mutual fund at 9:00 a.m. one day, you cannot. They only trade once at the end of a day. ETFs can trade at any time during the day.
- No short-term redemption fees. Many mutual funds charge a 2% penalty on funds sold in the first 90 days after purchase; ETFs do not have this provision.
My final point is that most ETFs are “passive” broad-market indexed based funds. They are meant to approximate the returns of the index they track. These index funds often have a very low annual internal fee because often a computer is selecting the investments based on the size of the underlying holdings in the index.
A new brand of ETF has emerged, called the “actively-managed ETF.” These are designed to employ active management and decision-making along with the advantageous ETF structure. The goal of actively-managed ETFs is to combine the inherent advantages over mutual funds, combined with an active approach designed to outperform the typical passive or index methodology.