Investing in ETFs Versus Mutual Funds

With continuous media attention, exchange traded funds are becoming synonymous in investor’s minds with low-cost investing. However, you cannot count traditional mutual funds out yet. In reality, for the typical investor who invests a little money upfront and hopes to derive several hundred bucks a month over 15 or 20 years, ETFs are likely to be more expensive than traditional index funds from providers like Vanguard Group Inc and Fidelity Investments.

While traditional index funds exist for decades, ETFs have become dear to financial advisors and Wall Street traders in the past few years, accumulating nearly $350 billion in assets. ETFs have become more popular as investors can trade them rapidly and ETFs expenses are perceived as being low. One frequently cited advantage of ETFs is that unlike traditional mutual funds, they rarely need to distribute capital gains, an event that can prompt tax bills for shareholders.

However, all the advantages of these funds, for small investor, seem much less dramatic if they don’t vanish entirely. For example, ETFs, unlike mutual funds, can be traded during the middle of the day. But for an average investor, saving for college or retirement, intra-day trading is not necessary and may sometimes lead to bad decisions. Also while ETFs’ expense ratio are often hyped as rock bottom, that claim is supported best when ETFs are compared to actively managed funds, which employ a stock-picker to try to beat the market. To some extent, credit goes to recent price cuts by Fidelity and Vanguard. The expenses for some of the most popular broad?market stock index funds are also competitive, if not sometimes lower than equivalent ETFs. In addition, since ETFs are bought and sold like a stock, they are traded through a brokerage account, adding extra cost. Every time you buy an ETF, it adds a transaction cost.

Unfortunately, there is no rule to decide when it is cheaper to invest in an ETF than a traditional index mutual fund. Many investors who look closely at ETFs may find that what is a great tool for moving in and out of the market quickly, isn’t necessarily the best option for basic month-to-month investing.