There are many good reasons why investors nowadays are putting money into exchange traded funds. Ever since they first appeared in 1993, the number of ETFs has increased to more than 1,600. Even though ETFs share a lot of similarities with mutual funds, you must also consider a lot of important difference between the two so you can make better investment decisions.
Variety of ETF Products
The first ETFs were introduced in the 1990s and they were created as passively managed funds that replicate the performance of a specific index like the S&P 500.
Nowadays, investors can choose from ETFs focusing on a particular industry or geographic region, and leveraged or inverse ETFs.
Average investors that have small investment portfolios and large hedge funds managing billions of dollars can find preferable ETFs to meet their investment objectives.
ETF Pricing
An exchange traded fund can have hundreds or even thousands of securities, but its shares trade exactly like the shares of an individual stock. The shares fluctuate in price intraday on a stock exchange and they also have bid and ask prices. Shareholder demand and market volatility can influence the market price of an ETF, which can lead to the shares trading at a premium or a discount to the ETF’s net asset value.
In contrast, shares of a mutual fund are priced at their net asset value once a day. The intraday pricing of an ETF means that ETF investors can control the timing of their trades, so they have the potential for outperformance. Intraday pricing can be particularly important to short-term investors and traders.
Flexible Trading
Investors place orders for ETFs through different brokerage accounts, which let them take advantage of the different types of buy and sell orders. For instance, an investor can place a limit order, stop-limit order, or a short-sale order.
He can also buy on margin if he has a margin account with his brokerage firm. This buy-and-sell flexibility, along with intraday pricing, gives the ETF investor the potential to leverage his investment returns.
Many ETFs also sport put and call options, which investors can buy and sell to hedge the risk in their portfolios. Mutual fund investors do not have similar order options when they buy and sell fund shares. Each and every investor who buys shares of a mutual fund on any day will have to pay the same NAV.
Transparency
For good reasons, most investors are eager to know what securities an ETF portfolio holds. For the case of mutual funds, the holdings are only disclosed on a monthly or quarterly basis.
ETFs provide daily disclosure of their portfolio holdings, including their top 10 holdings, industry sector allocations and geographic allocations.
ETFs also disclose their performance for both the market price and the NAV of the shares. All of such data is immediately available on financial websites.
Efficient with Taxes
Because ETF shares trade on the secondary market through various exchanges, each buy trade is matched with a corresponding sell trade. The ETF portfolio manager does not sell any stock in the portfolio when the fund’s shares trade.
On the other hand, when an investor wants to redeem, say, $10,000 from a mutual fund, the fund must sell $10,000 worth of stock from its holding to pay that redemption.
