Why buy ETFs instead of mutual funds?
ETFs typically have lower expense ratios compared to mutual funds because they're more passively managed. They disclose their holdings daily, allowing investors to see the underlying assets and make informed investment decisions.
Exchange-traded funds (ETFs) take the benefits of mutual fund investing to the next level. ETFs can offer lower operating costs than traditional open-end funds, flexible trading, greater transparency, and better tax efficiency in taxable accounts.
ETFs typically have low expenses because they track an index—this means there is only turnover within the fund when a company is removed from an index. For example, if an ETF tracks the S&P 500 Index, it might contain all 500 stocks from the S&P, making it a passively managed fund that is less time-intensive to manage.
Higher Management Fees
Not all ETFs are passive. Some ETFs are actively managed, meaning they're managed by a fund manager whose goal is to outperform the market. Actively managed funds often have higher fees since they require management to guide the fund.
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.
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.
In many ways mutual funds and ETFs do the same thing, so the better long-term choice depends a lot on what the fund is actually invested in (the types of stocks and bonds, for example). For instance, mutual funds and ETFs based on the S&P 500 index are largely going to perform the same for you.
Bottom line. ETFs make a great pick for many investors who are starting out as well as for those who simply don't want to do all the legwork required to own individual stocks. Though it's possible to find the big winners among individual stocks, you have strong odds of doing well consistently with ETFs.
You expose your portfolio to much higher risk with sector ETFs, so you should use them sparingly, but investing 5% to 10% of your total portfolio assets may be appropriate. If you want to be highly conservative, don't use these at all.
Should you invest in ETFs? Since ETFs offer built-in diversification and don't require large amounts of capital in order to invest in a range of stocks, they are a good way to get started. You can trade them like stocks while also enjoying a diversified portfolio.
Why am I losing money on ETFs?
Interest rate changes are the primary culprit when bond exchange-traded funds (ETFs) lose value. As interest rates rise, the prices of existing bonds fall, which impacts the value of the ETFs holding these assets.
These ETFs amplify market movements and can lead to substantial losses if they do not perform as expected. In short, they are riskier and may not be suitable for long-term investors. Many of the risks listed above can be amplified by leveraged and inverse ETFs.
Liquidation of ETFs is strictly regulated; when an ETF closes, any remaining shareholders will receive a payout based on what they had invested in the ETF. Receiving an ETF payout can be a taxable event.
SPY was launched in January 1993 and was the very first ETF listed in the U.S.10. Index investing pioneer Vanguard's S&P 500 Index Fund was the first index mutual fund for individual investors.
ETF | Assets under management | Expense ratio |
---|---|---|
Invesco QQQ Trust (ticker: QQQ) | $244 billion | 0.2% |
VanEck Semiconductor ETF (SMH) | $14 billion | 0.35% |
Consumer Discretionary Select Sector SPDR Fund (XLY) | $19 billion | 0.09% |
Global X Uranium ETF (URA) | $3 billion | 0.69% |
Both are less risky than investing in individual stocks & bonds. ETFs and mutual funds both come with built-in diversification. One fund could include tens, hundreds, or even thousands of individual stocks or bonds in a single fund. So if 1 stock or bond is doing poorly, there's a chance that another is doing well.
ETF investing comes with less control because investors don't select the individual assets in the fund. Instead, an expert does the work. However, individuals looking to avoid a particular company, sector, industry, or type of asset may prefer another investing strategy with a more hands-on approach.
Although similar to mutual funds, equity ETFs are generally more tax-efficient because they tend not to distribute a lot of capital gains.
These are VanEck Vectors Semiconductor ETF SMH, Invesco NASDAQ 100 ETF QQQM, Communication Services Select Sector SPDR Fund XLC, Vanguard Mega Cap Growth ETF MGK, and Vanguard Consumer Discretionary ETF VCR. These funds are likely to continue outperforming should the existing trends prevail.
One of the ways that investors make money from exchange traded funds (ETFs) is through dividends that are paid to the ETF issuer and then paid on to their investors in proportion to the number of shares each holds.
What are the pros and cons of ETFs?
In addition, ETFs tend to have much lower expense ratios compared to actively managed funds, can be more tax-efficient, and offer the option to immediately reinvest dividends. Still, unique risks can arise from holding ETFs as well as tax considerations, depending on the type of ETF.
ETFs can form a diverse foundation
The big advantage with ETFs is they offer an unmatched choice of assets, markets, and risk levels. That means there is probably an ETF to match your long-term needs at whatever life stage you are at. ETFs can help you build a strong foundation for your long-term investment portfolio.
Hold ETFs throughout your working life. Hold ETFs as long as you can, give compound interest time to work for you. Sell ETFs to fund your retirement. Don't sell ETFs during a market crash.
It might actually lead to unwanted losses. Investors that only invest in the S&P 500 leave themselves exposed to numerous pitfalls: Investing only in the S&P 500 does not provide the broad diversification that minimizes risk. Economic downturns and bear markets can still deliver large losses.
Meanwhile, if you only invest in S&P 500 ETFs, you won't beat the broad market. Rather, you can expect your portfolio's performance to be in line with that of the broad market. But that's not necessarily a bad thing. See, over the past 50 years, the S&P 500 has delivered an average annual 10% return.
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