It used to be that mutual funds were the best choice for investors
to save and grow their money. Today, exchange traded funds (ETFs)
offer a very attractive alternative for investors, but there are
some situations in which investors may be better-served by mutual
Exchange traded funds, like index mutual funds, offer investors
a variety of choices from which to invest in the market without
having to choose specific stocks,
reports Hans Wagner of Investopedia
. Moreover, ETFs offer three unique cost advantages to mutual
funds, although they also have two drawbacks. [
ETFs vs. Index Fund Costs.
The advantages are:
- ETFs tend to have lower expense ratios, which are management
fees calculated as a percentage of a fund's assets. Although the
percentage differential is usually small, overtime, a small
differential can become significant because of the power of
- ETFs, unlike mutual funds, do not require a minimum
investment, save for the cost of a share in the ETF. This makes
them more practical for small investors. [
The Long-Term Costs of High Fees.
- ETFs rarely generate capital gains. This is because of the
creation/redemption process and the fact that, as index tracking
products, there is generally lower portfolio turnover. [
The ETF Creation and Redemption Process
The disadvantages are:
- The transaction costs for buying and selling an ETF share can
amount to a significant percentage of the total amount being
invested. Like management fees, this will eat into your returns.
Financial Advisors Moving Into 'ETF Mutual
- There is a spread between the buying and selling prices of
shares, which also will eat into your returns.
- If you're investing small amounts - say, less than $2,000 -
you may be better-served by a mutual fund until you amass more.
Because of transaction costs, dollar-cost averaging and ETFs tend
not to mix. [
ETFs to Keep Dusting Mutual Funds.
The bottom line is that ETFs offer a very attractive way to make
periodical investments. If the transaction costs of
purchasing an ETF are too high, then it may be advisable to stretch
out the purchasing period or increase the amount being invested to
reduce the toll of transaction costs.
For more stories on ETFs, visit our
Sumin Kim contributed to this article.