Are ETFs Really Better Than Mutual Funds?
The ETF industry reached an historical milestone recently. The very first ETF, the SPDR S&P 500 ETF (SPY) or the “Spider”, just celebrated its 20th birthday.
And with that birthday, the ETF industry entered its 20th year in existence. It’s quite an accomplishment for an industry that began as a mere experiment.
But what’s even more impressive is the phenomenal growth of the ETF industry over that short period of time.
When the SPY (and the ETF industry itself) was launched on January 29, 1993, it was the only ETF available. And it had just $6.5 million in assets.
Today, there are more than 1,400 ETFs in the US holding over $1.4 trillion in assets.
While that trails the mutual fund industry’s $12 trillion in assets, there’s no question the ETF industry has enjoyed rapid success. And the most interesting part is that much of that success has come at the expense of mutual funds.
You see, ETFs and mutual funds are quite similar. Both give the investor an ownership interest in a portfolio of securities.
For example, whether you purchase the SPY or the Vanguard 500 Index (VFINX) mutual fund, you instantly acquire an ownership interest in each of the 500 stocks in the S&P 500. The main benefit of course is instant diversification through the purchase of a single security.
But ETFs also offer several advantages over their mutual fund cousins.
First of all, ETFs trade intra-day.
Unlike a mutual fund which can only be purchased or redeemed at the end of the trading day, an ETF can be traded throughout the day like a stock. In a volatile market, the ability to get in or out when you want could mean a greater profit or a smaller loss for you.
Another advantage ETFs have is their lower cost compared to mutual funds.
According to Morningstar, the average mutual fund charges a fee of 1.4% while the average ETF charges a mere 0.44%. What’s more, there are ETFs charging as little as 0.04%. Remember, the lower the annual fee, the greater the return on your investment.
Last but not least, ETFs give you greater control over your tax liabilities.
When your mutual fund generates capital gains, they must be distributed to you by the end of the year. These distributions are taxable even if you haven’t sold any of your mutual fund shares. What’s more, you have to pay taxes on these gains even if your fund is showing a loss.
Not so with ETFs.
ETFs allow you to defer paying taxes on your accumulated capital gains for as long as you own your shares. Only when you sell your ETF and realize your capital gains are you required to pay the appropriate tax on those gains.
So, are ETFs better than mutual funds?
The answer to this question is a personal one. You really need to decide for yourself which investment vehicle is best for you. But if you’re looking for a security that trades intra-day, has low expenses, and gives you control over your taxes, then ETFs are the way to go.
Profitably Yours,
Robert Morris
Category: ETFs
