10 Common Questions Investors Ask About ETFs
There's no denying the explosive growth in exchange-traded funds (ETFs). Over the past ten years, global ETF assets have increased from $580 billion to well over $3 trillion, growing at a clip that's more than three times faster than traditional mutual funds.
Mutual fund and ETF annual asset growth rate since 2006
Source: Morningstar and Vanguard calculations as of March 2017.
This is good news because it means investors are, largely, taking advantage of low-cost, broadly diversified investment options to a greater degree.
But if you're like many investors, you probably still have questions about ETFs and the role they should play in your portfolio. We asked Vanguard Head of ETF Product Management Rich Powers about some of the common questions he gets about this fast-growing investment vehicle.
1. What is an ETF?
Basically, an ETF is a mutual fund that trades on a stock exchange.
2. How are ETFs different from mutual funds?
3. Why have ETFs become popular?
While ETFs have been around for nearly 25 years, they’ve really exploded in the past five thanks to the recognition of the importance of low-cost investing.
4. Can you hold ETFs in your retirement account?
As long as your retirement account is a brokerage account, you can hold ETFs. In other words, if you can trade a stock in your retirement account, you can trade an ETF.
5. Are ETFs cheaper than mutual funds?
ETFs, which are predominantly index strategies, aren't necessarily cheaper than index mutual funds. At Vanguard, ETFs and AdmiralTM Shares (minimum $10,000) of our mutual funds are priced identically.
6. Why are ETFs often cited as cheaper?
Often, when people discuss ETFs' cost advantage, they're comparing ETFs with the broad universe of mutual funds. But ETFs tend to be cheaper than mutual funds on the whole because ETFs mostly follow a less expensive indexing strategy. More than seventy-five percent of all dollars managed by mutual funds are invested in the more expensive active strategies.
7. What are the advantages of ETFs over mutual funds?
ETFs offer intraday trading, which isn't necessarily an advantage or disadvantage—it simply may be more of a preference for some people.
8. What are the advantages of investing in mutual funds over ETFs?
Mutual funds offer the advantage of auto-investment, which is the option to automatically contribute a set amount at a predefined time. Again, this is more a preference than an advantage.
9. Are ETFs more tax-efficient than mutual funds?
ETFs aren't more tax-efficient, per se. The ETF construct of indexing allows for lower turnover, which can result in lower capital gains distributions.
10. Do you have a favorite ETF?
That's like asking if I have a favorite child. We're a family that stands behind the philosophy of low-cost and broadly diversified ETFs.
Vanguard ETF Shares are not redeemable with the issuing fund other than in very large aggregations worth millions of dollars. Instead, investors must buy or sell Vanguard ETF Shares in the secondary market with the assistance of a stockbroker. In doing so, the investor may incur brokerage commissions and may pay more than the net asset value when buying and receive less than the net asset value when selling.
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