What are the pros and cons of ETFs vs mutual funds? How should I think about researching these instruments?

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  • 7 out of 7 people found this answer helpful

    CFA, CFP® San Francisco, CA

    We generally prefer to use exchange traded funds (ETFs), but there are still certain circumstances in which mutual funds are a better choice for our customer accounts. First, let’s talk about the plusses of exchange traded funds, index funds in particular:

    1. Because exchanged traded funds are stocks and trade on an exchange, they can be purchased or sold with limit orders during the day, at known prices, rather than executed after hours at a net asset value to be determined as you with a mutual fund(open ended fund).

    2. The ETF fund’s holdings are in nearly all cases transparent daily. Mutual Funds release their holdings only quarterly, so you are always looking backward for as long as three months.

    3. The creation/redemption mechanism and low turnover of index ETFs allows an investor freedom from unexpected capital gains distributions. Because the manager does not have to sell underlying portfolio holdings to raise cash for redemptions, the cash raising takes place at the investor level, allowing for a high degree of personal control over tax liability.

    4. If the most attractively priced mutual fund share class is not available to the investor through his/her brokerage firm, it is likely that an equivalent ETF will have the lowest embedded management fees available, leading to improved long term performance.

    Mutual Funds continue to work better for our clients in certain cases, because they do trade at daily Net Asset Value (NAV), and because additional purchases and dividend reinvestments are free from transaction fees.

    1. Whenever there are relatively illiquid underlying investments in a fund, an ETF can trade at a premium or discount from the price of the holdings, particularly since the NAV is set at prior day’s market close, and is therefore “stale”. Take the NAV of a municipal bond portfolio for example. Its component bonds might rarely trade, so the NAV might be based in part on price estimates. The equivalent ETF might trade at a higher or lower price than the NAV, reflecting fast moving intraday opinion about where the municipal bond portfolio should be trading or other real-time market dynamics. That premium or discount element can persist for long periods, particularly in steadily progressing or steadily retreating market, leading to underperformance of your ETF investment return.

    2. If a client is making regular contributions to his/her account, multiple ETF purchases would incur multiple trading commissions. Additional mutual fund purchases would not incur such transaction costs. (Exception: some brokerage firms waive commissions if you are buying their proprietary label ETFs)

    3. If an investor is eligible for the most attractively priced mutual fund share class through the broker dealer, often by investing a minimum amount, the embedded management fees might be lower than an equivalent ETF, leading to improved investment performance.


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  • 2 out of 2 people found this answer helpful

    CFP® San Francisco, CA

    James and Lyman do an excellent job of outlining the advantages and possible disadvantages of ETFs.  Please read both responses.  Some additional points:

    1.  Custodial broker dealers are now offering transaction free ETFs.  TD Ameritrade our custodian offers about 100 ETF that trade with no transaction fee.  Generally the transaction free trades need to be held for a period of time to remain transaction free when sold.  This is done to discourage day trading with these ETFs.  These no transaction fee ETFs allow you to dollar cost average the purchase of these securities similar to some index mutual funds.

    2.  The question is pros and cons of ETF vs. mutual funds (not index mutual funds).  Actively traded mutual funds accomplish different goals than passive index ETFs.  Generally actively managed mutual funds do not perform as well as their indexes.  Nerdwallet has a headline article to the effect that only 24% of actively managed mutual funds outperformed their benchmark indexes.  Each year there are many actively managed mutual funds outperforming their benchmarks.  The problem is that from year to year it is different mutual funds outperforming.  Therefore it is very difficult to find those funds.  

    3.  With fees having such a large impact on performance the fees charged by actively managed mutual funds are much higher and when combined with your financial advisors fees can result in underperformance vs. a comparable portfolio of passive index ETFs.

    4.  Similar to mutual funds, new ETFs are being created at a rapid pace generally following popularity trends.  Be careful of the latest trends.

    5.  There are some good research tools available in the ETF and index area such as www.indexuniverse.com.  Also there are some good paid subscription websites.

    6.  Not all indexes are created equal.  Be aware of what you are purchasing.  Open up the box and compare the different indexes in each asset class you want to own.

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  • 2 out of 2 people found this answer helpful

    Decatur, GA

    Before I answer the question, in the interest of full disclosure, Index Strategy Advisors is a Registered Investment Advisory firm that specializes in the design and management of Exchange Traded Fund (ETF) portfolios. Our pure index strategies provide opportunistic tactical investing by identifying asset classes where relative over- and under-valuation exist, with tactical sector investments that are expected to outperform over longer periods of time. Our active approach to risk management is based on a quantitative process that continually analyzes the unique catalysts which impact market direction.

    ETF strategies offer investors the following advantages over mutual funds:

    Costs – the average ETF portfolio has fund fees well below 0.5%, whereas mutual fund portfolios have fees that generally exceed 1.0%. Due to compounding factors this fee saving makes a tremendous difference in portfolio performance over time.

    Diversification – ETF choices span the same investment spectrum that mutual funds do, along with the opportunity to take advantage of tactical investment opportunities due to the tremendous breadth of asset classes available.

    Tax efficiency – due to the nature and structure of ETF’s, tax efficiencies within the ETF space are significant. Investors should check with their tax advisor for specific details.

    Portfolio transparency – the majority of ETF portfolios disclose their holdings on a daily basis, whereas traditional mutual funds report on a quarterly basis. The greater transparency of ETF portfolios helps to prevent “style drift,” a phenomena where mutual fund managers stray
    from their stated investment mandates in search of returns and from their being “closet indexers,” where these managers charge active management fees for an investment style that “hugs” industry indexes and results.

    Ability to hedge portfolios – the greater tactical investment opportunities in ETF portfolios may allow investors a greater ability to “hedge” against their current market exposures, either in traditional stock, bond or fund investments or for non-standard investment holdings. These non-standard holdings may be single stock or industry concentrated portfolios, interest rate sensitive investments, tail risk management sensitive accounts, currency or commodity exposure or other unique considerations.

    There are several important considerations to keep in mind when investing in exchange-traded funds:

    Novelty – there is a lot of press and publicity surrounding the growth of exchange-traded funds as an investment vehicle. Any investor needs to research and understand how these funds may, or may not be, a part of their overall investment strategy. Just because an investment is new,
    or is getting press, is not the basis for inclusion in an investment portfolio.

    Investing – if an investor decides to use these funds then they need to determine what type(s) of funds they will utilize. Exchange-traded funds are being created every day and utilize all manner of investment criteria and methodologies that may or may not be suitable for an investor’s portfolio.

    Costs – there are all manner of trading platforms and managed products that an investor can utilize to access the exchange-traded fund market. Understand what costs and restrictions may be
    attendant to the investment program that you employ. A positive aspect of the open-end fund business has been the emphasis on long-term investing as a fundamental part of investment planning and the attainment of financial goals. This may be important to success in exchange-traded fund investing as well. Costs do matter.

    Service providers – many of the largest financial services firms have, or are, instituting exchange-traded fund offerings to their clients. This is all well and good but I offer some caveats. First, research the breadth and depth of their product offering. In this regard look into the scope of the offering, in how comprehensive the products and services are in relation to their competitors. Is the investment offering solely proprietary (in-house) products versus an open-architecture (multiple firm offerings) platform?  Then look into costs such as fees, commissions and the like. Next, look at minimums and trading restrictions, if any. Finally, see if their platform is a core business strategy or an ancillary, me-too service designed to prevent client and asset attrition that does not add value to you. A fundamental part of this analysis is the training, experience and knowledge of the personnel these firms dedicate to their offering.

    As for researching the issue of ETFs and mutual funds I would recommend utilizing independent industry trade groups, research firms and exchanges. Among those to consider would be the Investment Company Institute, Morningstar, Index Universe, the U.S. Securities and Exchange Commission and the various exchanges.

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  • 0 out of 0 people found this answer helpful

    CFA, CPA San Francisco, CA

    As with all investment products, there are pros and cons to using ETFs.  Here is my take:  

    The pros of ETFs:

    ETFs generally employ an objective, systematic investment strategy that allows an investor to track an underlying benchmark.

    ETFs typically have low management fees.  For broad index ETFs, fees and expenses are generally less than 50bps.  

    ETFs require no minimum holding period.  Some mutual funds impose fees on investors who hold fund investments for less than a designated time period, such as 60 or 90 days, in order to deter turnover.  

    ETFs offer intra-day liquidity.  ETFs are traded throughout the day on major stock exchanges, unlike mutual funds which trade only once per day.  

    ETFs generally maintain net asset value.  Any significant disparities tend to be eliminated by the creation and redemption process.

    ETFs are eligible for margin, which means they can be used as collateral for securities-based financing.  Mutual funds can be used for margin under more restricted rules.  

    The cons of ETFs:


    Trading at NAV is not guaranteed.  Because ETFs trade with a bid-ask spread, there is a "hidden" cost to the investor equal to the spread earned by the market-maker.  For thinly-traded ETFs, spreads tend to be wider so costs are higher to the investor.  Mutual funds trade at the end of each day at NAV.

    Commissions add to transaction costs.  Most ETFs incur the same commission as a stock trade.  Each $10 of commission is 10 basis points on a $10,000 trade, so investors must be cognizant of the total cost of trading.  For smaller investment amounts, no-load, no-transaction-fee mutual funds may offer a better option.

    Front-running can occur.  Because most ETFs are rules-based investment products, arbitrageurs and speculators can sometimes predict and trade against investment flows, adversely affecting fund returns.


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    Advisors offer free consultations to determine if you're a good fit for one another. Providing more information in the consultation request will help advisors have a better sense of what you're looking for. The advisor will contact you via email and set up a time to meet. Depending on the advisor, and your preferences, this could be an in-person or online meeting. You are under no obligation to engage them after meeting with them.
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