Exchange Traded Funds (ETFs) vs Mutual Funds

​While the number of publicly traded companies in the U.S. continues to decline from 7,300 in the 1990s to around 3,700 today, the number of ETFs continues to grow.  There are now over 5,000 ETFs traded globally and 9,400 mutual funds.  Money continues to move from funds to ETFs and from active management to passive (indexing).

Personally, I prefer ETFs over mutual funds for the following reasons:

1.      Lower Fees: ETFs have an average expense ratio of 0.38% compared to 1.08% for mutual funds.  This doesn’t mean all mutual funds are expensive.  There are many index mutual funds that have rock bottom fees like the Vanguard S&P 500 at 0.14%.  The main reason funds have higher fees is that many of them are actively managed whereas ETFs are passive.
2.      Transparency: When you own a mutual fund, you must wait for your quarterly report to determine what the fund owns along with the weightings on your various holdings.  ETFs provide daily updates, so you always know what you own.  Let’s say you own an international fund and you decide you are worried about China and don’t want to invest there.  You would have no idea until the end of the quarter whether or not your fund owned stocks in China.
3.      Flexibility: I’m probably more active than most investors so this feature is very important to me.  When you buy or sell a mutual fund, the settlement price is the closing price for the day.  With ETFs, you can buy and sell throughout the day just like individual stocks.  This gives you the opportunity to set a limit price and get the price you want when making the trade.  You can also go short with ETFs (you make money when prices fall) or trade options on ETFs (discussion for another day).
4.      Taxes: Mutual funds are always making changes to their portfolio.  When they do this, it triggers capital gains and losses.  When a gain is recognized by the fund, there is a capital gain distribution passed on to you that you need to report on your taxes.  When you own ETFs, you pay your taxes after you sell them, just like individual stocks.  For example, if I own an ETF in a taxable account and I have a nice gain, I may choose to hold on past one year to claim a long-term capital gain instead of a short-term capital gain.  (You pay a higher tax rate if the gain is short term).  
5.      Fun and/or Speculation:  The fun part about ETFs is that you can probably find one for any type of investment you want to make.  Not only do they have ETFs for stocks, bonds, commodities, real estate etc., you can also buy inverse ETFs (they go up when the market does down) and leveraged ETFs.  If you buy a 3x leveraged ETF and the market goes up 10%, your ETF would be up 30%.  The reason I added the word speculation is because many of these “fun” ETFs can get you into trouble if you are not careful.  When you can easily make big leveraged bets on the daily movement of oil prices, stock prices, volatility etc., you have crossed over from investing to speculating and it’s easy to get wiped out. 










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