Why ETFs Are A Better Choice Than Mutual Funds

With the plethora of investment tools at one’s hands and the concept of indexing flooding newswires, exchange traded funds (ETFs) and their counterparts are extremely attractive and for good reason.

An alert investment advisor has probably heard of ETFs but doesn’t really know what they offer.  In a nutshell, ETFs offer the ability to be traded intraday on an exchange, unlike traditional mutual funds which can only be bought and sold at the end of a trading day.  They give investors the ability to access hard to reach markets, like commodities, currencies and emerging markets, while being able to be sold short or utilized as a hedging tool.  They are open-ended structures, which makes them liquid.

Additionally, the vast majority of ETFs are passively managed and track an index as opposed to being actively managed, which generally drives up costs.  When it comes to taxes, ETFs are much friendlier than mutual funds due to their in-kind redemption and creation process, which prevents the trigger of capital gains and the fact that they rarely change their holdings, meaning they rarely have distributions.

Lastly, ETFs offer a characteristic that should be of utmost importance, transparency.  One knows exactly what and how many shares of stocks, bonds, futures contracts or swaps an ETF holds on a daily basis.  As for mutual funds, they are only required to disclose holdings on a quarterly basis.

Granted ETFs carry expense ratios, but they still tend to be lower than the front-end or back-end loads, 12b-1 fees, management fees and other expenses associated with mutual funds.  An investor knows exactly how much an ETF will cost without any hidden fees.  Mutual funds, on the other hands, only disclose costs at the end of the trading day. To add icing to the cake, most ETFs actually move in tandem with their indexes, whereas nearly 75% of mutual funds fail to match the performance of their benchmarks.

ETFs are a growing market and are here to stay.  At the end of the May 2010, ETFs and ETNs (exchange traded notes) boasted nearly $798 billion in assets with 995 different listed products.  Of all ETF providers, Black Rock is the king of the jungle earning nearly $1.4 billion per year in annual expenses.

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