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PROS AND CONS OF ETFs

PROS AND CONS OF ETFs

Haitham Sadek 0 Comments

The Pros Of ETFs

1 Intraday Liquidity: You can buy and sell ETFs at any time during the trading day. If the market is falling apart, you can get out at 10 a.m. In a mutual fund, you would have to wait until after the close of trading.

2 Lower Costs: Although it’s not guaranteed, ETFs often have lower total expense ratios than competing mutual funds. The reason is simple: When you buy shares of a mutual fund directly from the mutual fund company, that company must handle a great deal of paperwork to record who you are, where you live and to send you documents. When you buy shares of an ETF, you do so through your brokerage account, and all the record-keeping is done (and paid for) by your brokerage firm. Less paperwork equals lower costs.

3 Transparency: Holdings in an ETF are disclosed on a regular, frequent basis, so investors know what they are investing in and where their money is parked. Mutual funds, by contrast, only disclose their holdings quarterly, with a 30-day lag.

4 Tax Efficiency: Since ETF shares trade through various exchanges, each buy trade is matched with a corresponding sell trade. The ETF portfolio manager does not sell any stock in the portfolio when the fund’s shares trade. However, when an investor wants to redeem $10,000 from a mutual fund, the fund must sell $10,000 worth of stock from its holdings to pay that redemption. If the fund realizes a capital gain with the sale, that capital gain is distributed at year end among the shareholders. Mutual fund shareholders must pay taxes on the net capital gains realized from the turnover within the fund during the course of a year. Therefore, ETFs are more tax-efficient than mutual funds, since the investor can decide when to sell, realize capital gains or offset capital losses. He is in control of the tax consequences.

5 Greater Flexibility: Because ETFs are traded like stocks, you can do things with them you can’t do with mutual funds, including writing options against them, shorting them and buying them on margin.

The Cons Of ETFs

1 Commissions: The beauty of intraday liquidity does not come without costs: Typically, you pay a commission when you buy or sell any security, and ETFs are no different. If you regularly invest a small amount of money in an ETF—say, $1,000 per paycheck—those commissions can be cost-prohibitive.

2 Spreads: In addition to commissions, investors also pay the “spread” when buying or selling ETFs. The spread is the difference between the price you pay to acquire a security and the price at which you can sell it. The larger the spread—and for some ETFs, the spread can be quite large—the larger the cost.

3 Premiums and Discounts: When you buy or sell a mutual fund at the end of the day, you always transact exactly at its stated “net asset value” (NAV), so you always get a “fair” price. While mechanisms exist that keep ETF share prices in line with their fair value, those mechanisms are not perfect. At any given moment, an ETF might trade at a premium or a discount to its NAV.

4 General Illiquidity: While exchange-trading sounds great, not all ETFs are as tradable as you think. Some trade rarely, or only at wide spreads. These become very difficult to trade.

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