Why Exchange-Traded Funds Might Be Better For You Than Mutual Funds

Businessman writing ETF on blackboard concept.

Throughout their journey, investors generally become familiar with many different types of investment vehicles. Two of the more popular types of investment vehicles, in 2017, are mutual funds and exchange-traded finds (ETFs). While these two are similar in that they allow investors to better diversify their portfolios across a relatively high quantity of different stocks, it is important to remember that there are some distinct differences. In fact, there may even be some clear advantages that coincide with investing ETFs instead of mutual funds.

As a quick review, mutual funds are created when a group of investors from a fund that pools the money of many other investors in order to purchase specifically targeted stocks. Further, each day when the stock market closes (4:00 pm EST) earnings and losses are valued and fund managers use the information to make buy and sell decisions. Conversely, exchange-traded funds are investment funds that are traded throughout the day the same way that stocks are. In essence, market makers provide fractional shares of the underlying stocks to maintain share prices of the ETF that are near to the net asset value (or value per share on a specific day or time) of the underlying stocks. Furthermore, there are other advantaged to investing in exchange-traded funds over mutual funds — here are three:

Capital Gains Are Generally Not Realized Until You Sell:

One major difference between these two types of funds is the way that investors receive capital gains. For instance, mutual funds have the ability to push capital gains into a taxable account as the stock composition of the fund changes. On the other hand, shares of an ETF are assembled upon purchase and not broken up until they are sold. Therefore, capital gains are not realized until the investor chooses to sell. This is important because it gives investors more control over their investments.

Exchange-Traded Funds Offer Increased Transparency:

Transparency regarding investment decisions is extremely important when an individual investor trusts other investors with their money — specifically regarding investment vehicles. As such, the ability to stay up to date on information is another key advantage of investing in an ETFs instead of a mutual fund. Generally, mutual funds are only required to disclose their portfolio details one each quarter. Additionally, there is often a period of lag before the information reaches the investors — even as long as 30 days in some cases. In contrast, because shares of an ETF must be assembled upon purchasing them, the list of stocks that make up the share is disclosed at that time. Moreover, the list is usually updated daily. For investors who would like to know exactly where their money is going — which should be nearly all investors — exchange-traded funds might be a better option.

No Minimum Investment Requirement:

When investing in a mutual fund, it is not uncommon for the fund to have a minimum initial investment. In some cases, the required initial investment can even be thousands of dollars. Understandably, a thousand (or multi-thousand) dollar minimum could be intimidating to some people. This is especially true for those newer to investing who might not have thousands or even hundreds of dollars they are willing to start with. Fortunately, ETFs allow investors to buy single shares. In fact, using the DriveWealth App, investors can even purchase fractions of shares using the dollar-based system of investing if that is the best option for them!

As always, there is no investment strategy (or vehicle) that is perfect and this article is not telling investors that they must invest in exchange-traded funds. Likewise, it is each investor’s duty to do the independent research and due diligence necessary to make informed investment decisions. This is especially true because no two have the exact same experiences, goals, risk tolerances, and available capital. For instance, despite the advantages of ETFs pointed out above, investing in a mutual fund might be the best option for some individuals. Ultimately, the best way for investors to make sure an investment decision is the right one is through dedicating time towards expanding their knowledge of the subject matter.