Investing in the stock market and bond market is, without a doubt, an excellent way to increase your wealth and financial security. While there is a wide range of different financial products available for investment, Exchange Traded Funds (ETFs) and Mutual Funds are the most popular. But which option is right for you?
To help you make an informed decision, we’re going to look at the difference between exchange traded funds and mutual funds, costs and benefits of each product, as well as determine which option offers the most advantages. Well, read on to find out.
Exchange Traded Funds vs. Mutual Funds
An Exchange-Traded Fund (ETF) put simply, is an investment fund that’s traded on stock exchanges, much like stocks. ETF investors receive shares, similar to shares that are received by a stock owner.
This product holds assets such as stocks, bonds, gold bars, oil futures, foreign currencies, etc. and operates with an arbitrage mechanism that is created to keep it trading close to its net asset value, even though deviations can still occur on some occasions during the day.
Most ETFs track an index—bond index or stock index.
History of ETFs
The first attempt was the launch of index participation shares for the S&P 500 in 1989, but was ruled out as it worked like futures contracts, although they were collateralized and marginalized just like a stock. In the following year, Toronto stock exchange launched the second attempt to create a modern ETF—Toronto 35 Index Participation Units (TIPs 35). The TIPs 35 were simply a warehouse, receipt based tool that tracked the performance index of TSE-35.
The third attempt was in January 1993, when the American Stock Exchange successfully released the first ETF (called SPDR or Spider’ for short).The ETF was designed to track the S&P 500 stock index.
This ETF has now become very popular within the investment community. To back up that claim, it was revealed that investors held over $4 trillion in ETF products globally as of May 2017.
Today, individual and institutional investors have nearly 7,000 different ETF options.
A mutual fund is basically a pool of funds provided by individual investors, companies, and other organizations purposely for investing in the different securities— bonds, stocks, money market, as well as other similar assets. A money manager is responsible for professionally managing the mutual fund. His or her duty is to invest the mutual fund’s capital in order to earn capital gains and income for the funds provided by the investor. Well, there are two main types of fund managers:
• Fixed-income fund manager: Strives to provide the highest yield at the lowest risk.
• Long-term growth manager: Attempts to beat the S&P 500 in a fiscal year.
A mutual fund investor receives shares, which are similar to the shares that are received by a stock owner. However, most of the mutual fund shares are not traded on a stock exchange market like the common stock.
Investors purchase and redeem shares at the fund’s net asset value (NAV) per share. The net asset value is the total value of the securities in the investment portfolio divided by the total number of outstanding shares.
Brief History of Mutual Funds
The first mutual fund was launched in 1924. But individual investors generally invested on a small scale basis until in the 1950s. And over the years, the industry has experienced an increased participation thanks to the collaboration with the 1980s thriving bull market. It is estimated that investors held over $36 trillion in mutual funds products globally as of May 2017.
Today, individual and institutional investors have over 110k regulated mutual funds options.
Exchange Traded Funds Cost and Benefits
ETFs generally have a low-cost structure, that’s why they are a very popular investment option for individual investors. On average, ETFs attract 0.40% as an annual fee. Nevertheless, most investors invest a majority of the ETF dollars in index funds as they attract a slightly lower annual fee of 0.23%.
You’ll want to invest in firms such Vanguard, State Street, and BlackRock since they service nearly 70% of all ETF assets and have the ability to charge significantly lower fees than other companies in the industry. Regarded as the big three’ in the equity index space, they charge annual fees that are below the industry average, typically 0.04%.
Nowadays, more investors are investing in fixed income ETFs due to the decline of the average annual fee charged from 0.26% to 0.20%
Mutual Fund Cost and benefits
Although the fees charged on mutual funds have declined over the past few years, they haven’t been able to beat the ETFs. Two decades ago, the stock index mutual fund fees in the industry were 1.04%. Today, a typical stock index mutual fund will attract an average annual fee of 0.63%. Bond funds, on the other hand, have an average annual fee of 0.56%, but still, trail the ETF fee reductions.
ETF transaction typically involves less compilation when compared with mutual funds. Unlike mutual fund investors who trade with the company itself, most ETF investors trade with other investors, thus enjoy lower fees. In addition, ETFs tend to be more tax friendly.
Since mutual funds are managed by professional managers, there’s a price tag attached to the service. Thinking critically, a professionally managed account is certainly the main selling point. In the long run, the rate of return could prove that the additional expense of a managed account does not sufficiently compensate the investor.
Mark Soberman, the president and Founder of NetPicks, dropped the Mutual fund investment because of the low performance and added fees.
In a mutual fund company, processing a purchase or selling order from a customer is done internally, which requires extra charges in regards to record keeping, compliance, and documentation. Besides, a professional manager must invest the funds in the marketplace after the order has been processed successfully. This process typically involves buying and selling securities as well as meeting the cost of commissions. All these costs are passed to the investor.
Based our comparison, there’s no doubt that ETFs offer the most advantages for an investor. Needless to say, you’ll find that in the long run the ETF lower fee structure far outperforms the mutual fund investment.
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