Q. What are the advantages and disadvantages of buying ETFs vs. Index Mutual Funds?
A. First, let's discuss three major advantages of ETFs over Mutual Funds.
1. Low Costs for ETFs
We have discussed before that ETFs have inherent low cost structure. Based on Morningstar results, the average expense ratio for an ETF that tracks a broad mix of U.S. stocks is 0.38%, that ratio is 0.45% for no-load index mutual funds. If you add broker-sold index funds that charge commissions and the average expense ratio jumps to 0.73%, almost double that of ETFs.
If you run our Fund Expense Impact on Profit tool, you see appreciate why low expense is such a big deal, especially for long term investors.
2. Tax Efficiency for ETFs
When a fund managers make trades, most exchange-traded products have to distribute net realized capital gains to shareholders. Compared with other mutual funds, Index Mutual Funds make fewer trades because they are passively managed, but ETFs go one step further - they don't always have to sell holdings when an investor cashes out.
Of course, if you are investing in a tax-efficient account such as IRA, the above difference doesn't matter.
3. Flexibility for ETFs
You can always buy and sell ETF anytime at market price, or at limit price (it might not go through, though), For mutual fund investors, they have to wait till the market closes in order to find out how much they are buying or selling their funds.
Furthermore, you can buy as little as one share of an ETF, many mutual funds have minimum investment requirements.
In next blog post, we will discuss the major disadvantages of ETFs.
A. First, let's discuss three major advantages of ETFs over Mutual Funds.
1. Low Costs for ETFs
We have discussed before that ETFs have inherent low cost structure. Based on Morningstar results, the average expense ratio for an ETF that tracks a broad mix of U.S. stocks is 0.38%, that ratio is 0.45% for no-load index mutual funds. If you add broker-sold index funds that charge commissions and the average expense ratio jumps to 0.73%, almost double that of ETFs.
If you run our Fund Expense Impact on Profit tool, you see appreciate why low expense is such a big deal, especially for long term investors.
2. Tax Efficiency for ETFs
When a fund managers make trades, most exchange-traded products have to distribute net realized capital gains to shareholders. Compared with other mutual funds, Index Mutual Funds make fewer trades because they are passively managed, but ETFs go one step further - they don't always have to sell holdings when an investor cashes out.
Of course, if you are investing in a tax-efficient account such as IRA, the above difference doesn't matter.
3. Flexibility for ETFs
You can always buy and sell ETF anytime at market price, or at limit price (it might not go through, though), For mutual fund investors, they have to wait till the market closes in order to find out how much they are buying or selling their funds.
Furthermore, you can buy as little as one share of an ETF, many mutual funds have minimum investment requirements.
In next blog post, we will discuss the major disadvantages of ETFs.
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