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Business/Finance See other Business/Finance Articles Title: Why I Prefer ETFs Over Mutual Funds Why I Prefer ETFs Over Mutual Funds Posted on October 21, 2015 by Brad Hoppmann There’s no sugar-coating the hit that Exchange-Traded Funds took to their collective reputation this summer. After all, I don’t think many people will soon forget that it was just about two months ago that ETFs suffered perhaps their biggest black eye ever. The date was Monday, Aug. 24, and by the looks of the bright red pre-market trading screens that day, it was shaping up to potentially be another dreaded "Black Monday." That fear was thought to be confirmed at the outset, as the Dow plummeted some 1,100 points in just the first five minutes of trading. The huge point slide was scary, but it only represented about a 5% decline. I say "only," because when compared to some heavily owned, S&P 500 index-oriented ETFs, a 5% decline was pocket change. To give you a sense of how really scary things became, during the first five minutes of Aug. 24, the iShares Core S&P 500 ETF (IVV) had plunged 25%. The SPDR S&P Dividend (SDY) dove nearly 40%, and the PowerShares S&P 500 Low Volatility ETF (SPLV) had plummeted some 45% in just the first five minutes of trade. That kind of battering is hard to spin as anything but downright ugly. *** So, what caused this crazy mispricing of ETF assets? There were a number of reasons, including a major imbalance between sell orders and buy orders before the opening bell. Then there was the SEC’s "Rule 48," which caused a lack of transparency and had traders basically selling blindly. Finally, circuit-breaker rules that halted trading for short periods caused order backups. This combination accounted for the wild mispricing shortly after the open. The market corrected the mispriced ETFs relatively soon after the initial price plunges. But the declines still caused a lot of investors a lot of lost money, as many sell stops were triggered at extremely low prices. In the aftermath of the black eye on ETFs, I heard many people saying that these investment vehicles were just too dangerous for the average investor, and that the average investor should just stick to traditional mutual funds. I beg to differ. I like to use mutual funds in my 401(k), and I recommend investors do the same. But that’s also mainly because mutual funds are about your only option in a 401(k), or 403(b)-like accounts. For self-directed retirement accounts, taxable investment accounts and especially for trading accounts, ETFs are still among the best tools of the trade, and for several key reasons. 1) Lower fees. While there are some low-fee mutual funds, most mutual funds are far more expensive than ETFs. Management fees of around 2% are common on many mutual funds, while expense ratios on similar ETFs are often as low as 0.15%. Then with mutual funds there usually are hidden costs such as exit fees, sales loads and other fees that are rarely disclosed or adequately explained. If you want to keep more of your money, make ETFs your preferred fund choice. 2) Tax efficiency. ETFs are more tax-efficient than mutual funds, because most ETFs are passive, transparent investments usually pegged to an index. That means the only time you have a taxable event (a capital gain) to report is if an index is rebalanced. With actively managed mutual funds, the turnover rate is usually quite high. Often, that ends up generating taxable events such as having to report a capital gain (or a capital loss). 3) Flexibility and sector access. If you want access to stocks and bonds, most mutual funds will get you there (albeit at a higher cost than ETFs). Yet if you want to invest with leverage … invest in the opposite direction of a sector (inverse funds) … or invest in sectors such as currencies, commodities or specific countries … then ETFs are the easiest way to do so. They are also the most cost-efficient, and tax-efficient ways to do so. The enormous growth of ETFs since 2001 (between 2001 and July 2014, the total number of ETFs climbed from 102 to 1,375, according to the Investment Company Institute) has brought along with it some growing pains, as evidenced by the Aug. 24 incident. Still, I think that when it comes to taxable accounts, and especially for sector and swing trading recommendations such as those we offer in my 10-Minute ETF Trader service, there simply is no better investment tool. *** In the news today, another "E" word took center stage … elections. Post Comment Private Reply Ignore Thread
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