Which Is Better? ETF vs Mutual Fund
ETF’s are relatively new investment vehicles and while they do have some similarities with Mutual Funds, there are also many differences. Let’s take a look at some of those differences so you may decide for yourself which is a better investment for you, ETF or Mutual Fund.
1) Timing your trades: With traditional mutual funds, you place your sell or buy order and it does not get executed until the end of the day. You have no control over the price you get for selling or the price you get for buying.
Since ETFs trade like stocks, you can buy and sell them all day long and and control the price. You can also do limit orders. You can tell your broker at what price you want to pay. This keeps you from getting caught in any trading frenzy and over paying.
2) Shorting is another possibility. For everyone who feels the market is overpriced, you can trade that an index will fall in value, and profit from it.
3) Making the minimum: If you’ve ever tried to invest in a no-load index funds, you might have discovered the high minimums required, some as high as $50,000. That’s the price of entry for some index mutual funds. If you have less than that, try opening an IRA, usually the minimums are much lower.
With ETFs there are no minimums. You can purchase as few shares as you like. Even if you wanted yo purchase just one share, you can do it. Just be careful and watch the costs of your commissions. You don’t want them eating up all of your profits.
3) Like Averaging? No-load Mutual Funds do not charge transaction fees, buying ETFs does. If you plan to buy a few hundred dollars’ worth of an ETF once a month, the brokerage fees could take a big bite of your nest egg and makes a no-load index mutual fund a much better bet.
But with the advent of discount brokerages you can make trades for just a few dollars, however, your orders must be enetered manually, as you would to purchase a regular stock.
4) Options: ETFs offer more advanced trading possibilities and options are one of them (we cover other ETF investing strategies here.) With ETF’s you have the right to “call” or “put” (buy or sell) shares of the ETF, you can’t do this with mutual funds.
Here is an example. Let’s say I buy TNA for $80. I figure it will go to $90 in two weeks. So right after I purchase my shares of TNA, I sell a “call” option to another investor giving him the right to buy my ETF’s at $90 in two weeks. If I’m correct, in two weeks I make $10 a share on the ETF AND I get to keep all the money I received for selling the “call”.
If I’m wrong on the trade, the money I received from selling the “call” helps cover some of my losses on the ETF. Kind of like insurance.
5) Dividend Reinvestment: With a Mutual Fund, when a dividend is paid, the money is automatically reinvested into the Mutual Fund. With an ETF, the dividend is placed into your cash account and you have to manually reinvest and pay commission fees. Your broker may allow for automatic reinvestment of your ETF dividends. Ask your broker for their company policy.
6) Taxes: ETF profit and losses are not reported to the IRS while mutual funds are. But just because your broker is not reuired by law to report your activity does not mean that your are exempt from paying taxes. Just like a mutual fund, trading activity with your ETF’s stillneeds to be reported on your tax return (consult with your tax advisor on this).
If you are trading ETF’s in an IRA or employer-sponsored retirement plan, your gains are tax free until you start collecting.
There you have it: Mutual Funds v. ETFs. Now the choice is yours, which are you going to invest in? If you like the advantages an ETF offers, read on for some investing strategies.