There are thousands of mutual funds to select from and they come in many flavors. There are
inexpensive to manage index funds that follow a specific part of the market such as large US stocks,
foreign stocks or high yield bonds. We refer to these as passively managed funds.
Professionally managed funds are called actively managed funds. The active manager desires to provide
investment performance that will exceed their relative index. Actively managed funds are generally
more expensive than an index fund as there are higher operating expenses for the fund.
So what is different about an ETF? While it also is a pooled investment account, it primarily tracks the
returns of hundreds of US and foreign indexes. As most of them are passively managed, they usually
have low management fees and operating costs. According to Morningstar Investment Research, the
typical ETF annual fee is 0.44% while the average traditional index mutual fund is 0.74%. While there
may be a small trading cost to acquire an ETF, there are no commissions and no account minimums to
purchase shares either. Unlike a mutual fund which is valued at the end of a trading day, ETF’s trade
throughout the day which may be advantageous to an investor during bouts of volatility.
In the construction of a portfolio, an investor may want to view the holdings of a fund so as not to
duplicate a large position in a stock. ETFs offer daily transparency of their holdings, while most mutual
funds provide that information semi-annually.
Because of the way ETFs are created and redeemed, they are more tax-efficient than mutual funds. A
mutual fund has to sell shares to provide for redemption; oftentimes the shares that are sold have
appreciated, creating a long-term capital gain at year end for the shareholder. An ETF does not sell
shares; they provide an “in-kind redemption” which limits the possibility of capital gains.
Be aware that there are leveraged ETF’s which amplify the returns of the underlying assets. These are
truly designed for short-term trading and not advisable for unsophisticated investors. A wrong bet on
market movements can be glorious or tragic!
According to Bloomberg, as of December 31, 2014 there were 1,451 ETF funds in the US with $1,979
billion in assets. They may be invested in stocks of a very specific sector such as healthcare, home
construction, consumer durable or technology stocks. You can also own an index of a country or a
region, say Japan or Europe. The fund can be hedged to the US dollar or not.
There are a wide variety of ETF fixed income options as well from US Treasuries, to municipal bonds to
emerging market bonds.
There is no one solution to designing and maintaining an investment portfolio to meet to your financial
goals. As an advisor, we are happy to have the ability to use a combination of mutual funds and ETFs to
best serve our clients.
Roxanne E. Fleszar, CFP, ChFC is President of Financial Resources Management