Is it better to own ETF or mutual fund?
The choice comes down to what you value most. If you prefer the flexibility of trading intraday and favor lower expense ratios in most instances, go with ETFs. If you worry about the impact of commissions and spreads, go with mutual funds.
ETFs have several advantages for investors considering this vehicle. The 4 most prominent advantages are trading flexibility, portfolio diversification and risk management, lower costs versus like mutual funds, and potential tax benefits.
For instance, some ETFs may come with fees, others might stray from the value of the underlying asset, ETFs are not always optimized for taxes, and of course — like any investment — ETFs also come with risk.
A mutual fund provides diversification through exposure to a multitude of stocks. The reason that owning shares in a mutual fund is recommended over owning a single stock is that an individual stock carries more risk than a mutual fund. This type of risk is known as unsystematic risk.
Mutual funds are usually actively managed, although passively-managed index funds have become more popular. ETFs are usually passively managed and track a market index or sector sub-index. ETFs can be bought and sold just like stocks, while mutual funds can only be purchased at the end of each trading day.
Mutual funds are available for all different types of investment strategies, risk tolerance levels, and asset types. ETFs can be limiting as they are mostly passively managed indexed funds that invest in the same securities and mirror the chosen index.
In terms of safety, neither the mutual fund nor the ETF is safer than the other due to its structure. Safety is determined by what the fund itself owns. Stocks are usually riskier than bonds, and corporate bonds come with somewhat more risk than U.S. government bonds.
Low Liquidity
If an ETF is thinly traded, there can be problems getting out of the investment, depending on the size of your position relative to the average trading volume. The biggest sign of an illiquid investment is large spreads between the bid and the ask.
Leveraged ETF prices tend to decay over time, and triple leverage will tend to decay at a faster rate than 2x leverage. As a result, they can tend toward zero.
If you own ETF shares, you will receive cash equivalent to the value of your holding on the day of liquidation (not the value on the last day of trading).
What is a disadvantage of owning a mutual fund?
Mutual funds come with many advantages, such as advanced portfolio management, dividend reinvestment, risk reduction, convenience, and fair pricing. Disadvantages include high fees, tax inefficiency, poor trade execution, and the potential for management abuses.
- Invesco India Contra Fund.
- Bandhan Sterling Value Fund.
- Nippon India Value Fund.
- ICICI Prudential Value Discovery Fund.
In order of liquidity, the most liquid investments include: Money – actual cash currencies. Money market assets – short-term debt securities such as CDs or T-bills. Marketable securities – stocks or bonds.
The choice comes down to what you value most. If you prefer the flexibility of trading intraday and favor lower expense ratios in most instances, go with ETFs. If you worry about the impact of commissions and spreads, go with mutual funds.
The administrative costs of managing ETFs are commonly lower than those for mutual funds. ETFs keep their administrative and operational expenses down through market-based trading. Because ETFs are bought and sold on the open market, the sale of shares from one investor to another does not affect the fund.
- ProShares Bitcoin Strategy ETF (BITO)
- Invesco QQQ Trust (QQQ)
- Vanguard Information Technology ETF (VGT)
- VanEck Semiconductor ETF (SMH)
- Invesco S&P MidCap Momentum ETF (XMMO)
- SPDR S&P Homebuilders ETF (XHB)
- Invesco S&P 500 GARP ETF (SPGP)
If you're paying fees for a fund with a high expense ratio or paying too much in taxes each year because of undesired capital gains distributions, switching to ETFs is likely the right choice. If your current investment is in an indexed mutual fund, you can usually find an ETF that accomplishes the same thing.
The single biggest risk in ETFs is market risk.
At least once a year, funds must pass on any net gains they've realized. As a fund shareholder, you could be on the hook for taxes on gains even if you haven't sold any of your shares.
While there is no precise answer for the number of funds one should hold in a portfolio, 8 funds (+/-2) across asset classes may be considered optimal depending on the financial objectives and goals of the investor. Further, higher allocation of portfolio to the right fund is of crucial importance.
Why are mutual funds more risky?
Mutual funds are required to adhere to a certain set of rules and regulations. Non-compliance of the prescribed laws and practices may lead to several problems including the dissolution of the fund. Mismanagement of the mutual fund is a major risk that you would have to account for.
Ticker | Fund name | 5-year return |
---|---|---|
SOXX | iShares Semiconductor ETF | 30.70% |
XLK | Technology Select Sector SPDR Fund | 24.57% |
IYW | iShares U.S. Technology ETF | 24.09% |
FTEC | Fidelity MSCI Information Technology Index ETF | 22.79% |
ETFs offer advantages over stocks in two situations. First, when the return from stocks in the sector has a narrow dispersion around the mean, an ETF might be the best choice. Second, if you are unable to gain an advantage through knowledge of the company, an ETF is your best choice.
Why Invest in ETFs Rather Than Mutual Funds? ETFs can be less expensive to own than mutual funds. Plus, they trade continuously throughout exchange hours, and such flexibility may matter to certain investors. ETFs also can result in lower taxes from capital gains, since they're a passive security that tracks an index.
ETFs can be safe investments if used correctly, offering diversification and flexibility. Indexed ETFs, tracking specific indexes like the S&P 500, are generally safe and tend to gain value over time. Leveraged ETFs can be used to amplify returns, but they can be riskier due to increased volatility.
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