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Are Exchange Traded Funds Better Than Mutual Funds?

Some Facts to Help New Investors Understand the Differences

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ETF Investing Asset Allocation

Exchange traded funds, or ETFs, offer many of the advantages of mutual funds including widespread diversification, as well as the ability to buy and sell them throughout the day. This means that investors can access their money quicker.

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Exchange traded funds, or ETFs, can be a better choice for some new investors than mutual funds because they offer several advantages. You learned the basics in All About ETFs. Now, consider a few of the benefits:

  • Most mutual funds can only be bought or sold at the end of every trading day. Orders placed throughout the day are aggregated and "settled" at 4:30 p.m. Eastern Standard Time. If you need your money before then, you are out of luck. An exchange traded fund, on the other hand, can be bought or sold throughout the day because they trade just like stocks.
  • You cannot borrow on margin against shares of most mutual funds. You can borrow on margin against most exchange traded funds. This entails risk but can also allow you to draw cash from your account for short-term needs.
  • Many exchange traded funds have expense ratios as low or lower than low-cost index funds. For example, a well-known exchange traded fund designed to mirror the returns of the S&P 500 may have an expense ratio of only 0.10% annually, or 10 basis points. That means for every $10,000 you invest, you would indirectly pay the fund management company $10 each year. As an investor, you can't expect much lower costs than that, meaning more money stays in your portfolio to grow and compound.

By using ETFs you can achieve widespread diversification or the cost of a regular brokerage commission. For example, an investor could buy the Dow Jones Industrial Average iShares (Ticker Symbol IYY), the Cohen & Steers Realty Majors Index Fund (Ticker Symbol ICF), Barclays Aggregate Bond Fund (Ticker Symbol AGG), the COMEX Gold Trust (Ticker Symbol IAU), and the Silver Trust (Ticker Symbol SLV). Those five exchange traded funds would result in widespread diversification by both issue and asset class. If a new investor used a discount broker to make the purchase, it might cost less than $70 in commissions! This simply wasn't possible only a few short years ago.

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