What advantages do exchange-traded funds have over mutual funds?

By Steven Merkel AAA
A:

Exchange-Traded Funds (ETFs) are growing ever more popular, as they were created to combine the best characteristics of both stocks and mutual funds into a combined investment vehicle.

Four of the common advantages of ETFs over mutual funds include the following:

  1. Tax-Friendly Investing - unlike mutual funds, ETFs are very tax-efficient. Mutual funds typically have capital gain payouts at year-end, due to redemptions throughout the year; ETFs minimize capital gains by doing like-kind exchanges of stock, thus shielding the fund from any need to sell stocks to meet redemptions. Therefore, it is not treated as a taxable event.

  2. No Investment Minimums - Several mutual funds have minimum investment requirements of $2,500, $3,000 or even $5,000. ETFs, on the other hand, can be purchased for as little as one share.

  3. Lower Cost Alternative - The average mutual fund still has an internal cost well over 1%, whereas most ETF funds will have an internal expense ratio typically between 0.30-0.95%. Plus, ETFs do not charge 12b-1 fees (advertising fees) or sales charges, as do many mutual funds.

  4. More Trading Control - Mutual funds are traded once per day at the closing NAV price. ETFs trade on an exchange all throughout the trading day, just like a stock. This allows you greater purchasing/selling price control and the ability to set protection features, such as stop-loss limits on your investments.

For additional reading, check out Mutual Fund Or ETF: Which Is Right For You?

This question was answered by Steven Merkel

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