Introduced in the 1980s, exchange-traded funds (ETFs) are a popular alternative to mutual funds. Both individual and institutional investors are attracted to the benefits of holding a certain number of stocks with higher intraday visibility and lower management fees. However, lower management of the fund places the burden on the investor to choose a proper investment. Identifying the advantages and disadvantages will help you avoid risk and achieve reward.
Lower Fees in ETFs
Because ETFs are passively managed, the expense ratio is much lower than managed funds. The expense ratio of a managed fund is usually higher because of management fees, service fees and the need to pay a board of directors. Fees such as marketing payments and fees for sale and distribution are also common with managed funds but not ETFs.
Diversify in ETFS
Unlike a stock, the ETF will track a larger range of stocks and will even try to mimic the returns of a specific country or collection of countries. Most investors concentrate on countries such as Brazil, China and Russia. You can diversify mutual funds too but ETFs trade more like an equity investment and they have lower fees too.
Stock Trades
Although ETFs offer the investor the chance to diversify, they still essentially trade like a stock. ETFs trade at prices that are continuously updated throughout the day as opposed to mutual funds that are priced at the end of the day. Like stocks, ETFs allow the investor to manage risks by trading futures and options.
Reinvest Dividends Immediately
The dividends for an indexed mutual fund are reinvested at various times. Dividends for ETFs are usually reinvested immediately. However, unit investment trust ETF dividends are not always reinvested straightaway, causing what is known as a dividend drag. ETFs can also be tracked via the internet, and there is even a mobile application.
Higher Costs of Mutual Funds vs ETFs
When compared with mutual funds, ETFs are far more cost-effective. However, if you compare ETF investment to specific stocks, the costs are actually higher. The actual commission charged by the broker is the same, but stocks do not have a management fee.
