Why buy an ETF instead of a mutual fund?
ETFs offer numerous advantages including diversification, liquidity, and lower expenses compared to many mutual funds. They can also help minimize capital gains taxes. But these benefits can be offset by some downsides that include potentially lower returns with higher intraday volatility.
- Trading fees.
- Operating expenses.
- Low trading volume.
- Tracking errors.
- The possibility of less diversification.
- Hidden risks.
- Lack of liquidity.
- Capital gains distributions.
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.
ETFs give you an efficient way to diversify your portfolio, without having to select individual stocks or bonds. They cover most major asset classes and sectors, offering you a broad selection.
Another benefit of ETFs is their pricing transparency. Because they are traded on the ASX, you can see the price of your investment at any time during each trading day. By comparison, pricing for managed funds is typically provided far less regularly, on a daily, weekly or even a monthly basis.
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 single biggest risk in ETFs is market risk. Like a mutual fund or a closed-end fund, ETFs are only an investment vehicle—a wrapper for their underlying investment. So if you buy an S&P 500 ETF and the S&P 500 goes down 50%, nothing about how cheap, tax efficient, or transparent an ETF is will help you.
Limitations of ETF investments
It is crucial to take these into account before making any investment decisions: Reduced potential for returns: Due to their passive tracking of an index, ETFs may not exhibit significant outperformance of the market over the long term when compared to actively managed funds.
For most individual investors, ETFs represent an ideal type of asset with which to build a diversified portfolio. 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.
ETFs are generally considered more tax-efficient than mutual funds, owing to the fact that they typically have fewer capital gains distributions. However, they still have tax implications you must consider, both when creating your portfolio as well as when timing the sale of an ETF you hold.
Should I just put my money in ETF?
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.
Exchange-traded funds (ETFs) are ideal for beginning investors due to their many benefits, which include low expense ratios, instant diversification, and a multitude of investment choices. Unlike some mutual funds, they also tend to have low investing thresholds, so you don't have to be ultra-rich to get started.
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.
Active Management Without Leverage Risk
While these securities track a given index, using debt without shareholder equity makes leveraged and inverse ETFs risky investments over the long term due to leveraged returns and day-to-day market volatility.
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.
ETFs don't often have large fees that are associated with some mutual funds. But because ETFs are traded like stocks, you may pay a commission to buy and sell them, although there are commission-free ETFs in the market. To be fair, mutual funds do offer a low cost alternative: the no-load fund.
Market-driven pricing vs. NAV stability in mutual funds impacts investor strategy. ETFs minimize capital gains compared to mutual funds, boosting after-tax returns. ETFs offer trading versatility and lower fees, while mutual funds may provide active management at a higher cost.
We recommend Vanguard S&P 500 ETF (VOO) (minimum investment: $1; expense Ratio: 0.03%); Invesco QQQ ETF (QQQ) (minimum investment: NA; expense Ratio: 0.2%); and SPDR Dow Jones Industrial Average ETF Trust (DIA). (minimum investment: none; expense Ratio: 0.16%).
ETFs usually carry a lower fee and can trade intraday like stocks. While the diversified kind nature of both mutual funds and ETFs can make them appealing to less risk-tolerant investors, but they still carry market risks that investors should consider know before investing.
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).
Is it smart to only invest in ETFs?
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.
An ETF with a low risk rating can still lose money. ETFs do not provide any guarantees of future performance. As with any investment, you might not get back the money you invested.
For most ETFs, selling after less than a year is taxed as a short-term capital gain. ETFs held for longer than a year are taxed as long-term gains. If you sell an ETF, and buy the same (or a substantially similar) ETF after less than 30 days, you may be subject to the wash sale rule.
The takeaway
As someone who values low fees, passive management, and high transparency, I personally feel that Fidelity's selection of ETFs is lacking. But if you're a fan of active management, Fidelity has a few unique ETFs that might be worth considering for your portfolio. Learn more about ETFs: Commission-free ETFs.
Symbol | Name | 5-Year Return |
---|---|---|
TECL | Direxion Daily Technology Bull 3X Shares | 41.78% |
SOXL | Direxion Daily Semiconductor Bull 3x Shares | 36.11% |
SMH | VanEck Semiconductor ETF | 34.07% |
TQQQ | ProShares UltraPro QQQ | 33.93% |