Over the past few months, I have not been shy about my preference for ETF’s over mutual funds and how eventually I would expect ETF’s to take away a lot of the funds under management currently invested in mutual funds. I was having a good discussion with my friend Mike from TheFinancialBlogger and while he had good points, I remained convinced that in almost all cases, ETF’s are a better product for the investor. We finally agreed not only to disagree but to voice our arguments in writing on our blogs. So after reading this post, you can go on TheFinancialBlogger and read Mike’s arguments in favor of mutual funds. I’m still having trouble believing he thinks mutual funds are superior (will explain later) but it should be interesting to see what he can come up with You can read his post about ETFs vs. Mutual Funds.
Just before starting, I will point out a few differences between the two:
-Mutual funds are basically funds that investors can buy units of. Investors buy the units directly from the fund manager and can then sell the units at any point on time in the same way.
-ETF’s are similar funds but they are traded on stock exchanges and can be traded at any time of the day.
So here we go, the top 10 reasons ETF’s are superior to mutual funds
10-Trade at any time: Why would you settle for a mutual fund where you can only trade at the end of each day. If at noon you see market crashing and want to get out, with a mutual fund you are out of luck. You will send an order, but will only get the end of day price!
9-Rebalancing: As the market and the economy changes, you will likely want to change how you allocate your investments, perhaps putting more emphasis on fixed income or on emerging markets or simply scaling back into safer, less volatile funds. Guess what, with an ETF, you are about 2 clicks away from changing your asset allocation. With mutual funds? Well, first start by calling the managing company, explain what you want and hope that it is possible without too many extra fees!
8-Do like the big guys: Do you think it just happens to be that big institutions and brokers do not invest or trade mutual funds? Think it just happens to be that the only thing they do is sell them? They do not want to pay more, have less flexibility, etc. ETF’s on the other hand are getting huge institutional volume because they are liquid, cheap and easy to understand.
7-Transparency: Ever wondered what exactly is happening inside the mutual fund you purchased? Well, with some luck, you will be able to see the biggest positions that were held in your fund at the end of the last quarter. No, not all of them, not the cash, but the bigger positions, usually the top 5. Compare that to ETF’s. On any given day, you can see exactly what is in each share, which positions, how many, and how much cash. To me, that feels a lot more transparent
6-No entry or exit conditions: Many mutual funds carry conditions. You must invest a minimum, or commit to regular investments. You have to remain invested for a given period of time or pay a penalty, etc. Again, ETF’s do not have such conditions, you can buy and sell in a minute, a month or a year, it makes no difference, you are FREE!
5-More options: ETF’s offer almost unlimited possibilities. You can buy positions on sectors, commodities, bonds, inflation protected bonds, target specific countries or regions, etc. Generally, mutual funds are less flexible and usually are only used to track specific equity indexes or do active investing compared to an equity benchmark.
4-Strategy flexibility: You want to trade on margin when buying ETF’s? Or do you want to do an options strategy to limit your downside during a crash instead of selling the whole investment? Maybe you were thinking of having a short position for a little while? Good luck doing those things with mutual funds, they are pretty much impossible. But with ETF’s? Easy!
3-Tax Efficiency: As you get closer to retirement and assets grow, the important of tax efficiency in your investments takes a growing important. For various reasons, ETF’s are much more tax efficient! There are many reasons for this. One of them is that with mutual funds, every time an investor buys or sells shares, the total number of shares changes. Because of this, there is a lot more trading “inside the fund”. For example, if investors sell an important amount of shares, the fund will have to sell shares from their index, while will cause capital gains taxes. If those same investors come back to buy, the fund will get back to that initial quantity but will have paid more taxes. On the other hand, ETF’s have less problems because investors selling will be selling to other investors so the underlying index owned by the ETF company is not affected. Over time, this has an effect on the return.
2-Commissions: Most mutual fund buyers are convinced to do so by sales people or financial advisors. Wonder why? Commissions!!! They actually get an annual commission in most cases on your assets. So it’s a good deal for them… You pay a little more fees, but they get more commissions, win-win right? Oh except you are the loser!
1-Less Fees: Mike’s argument will be that you have to pay a commission on every ETF trade while every mutual fund transaction does not carry fees. That is true of course, but considering a 3000$ investment, the commission of 10$ from a standard broker represents .33%. Mike actually asked me to compare an ETF (XIU) with a mutual fund that tracks the same index from Altamira. They had a .40% fee difference. So even keeping that investment for one year will make you a winner. Imagine if you keep the investment for 10 years… you will end up saving .40% annually!!!
Let’s get to the point though.. all of these arguments are great but numbers only will close the debate right? Then, here are some numbers! Over 5 years, these are the returns of the TSX60, and the two funds:
SPTSX60 = 56.73%
XIU = 55.70%
ALTAMIRA = 52.80%
Do you even need to hear more? Didn’t think so. Case closed! You can still take a look at Mike’s post about ETFs vs. Mutual Funds And also, be sure to read about the 6 things to look at when selecting an ETF.