Are ETFs better than funds?
ETFs and index mutual funds tend to be generally more tax efficient than actively managed funds. And, in general, ETFs tend to be more tax efficient than index mutual funds. You want niche exposure. Specific ETFs focused on particular industries or commodities can give you exposure to market niches.
For instance, some ETFs may come with fees, others might stray from the value of the underlying asset, ETFs are not always optimized for taxes, and of course — like any investment — ETFs also come with risk.
The choice comes down to what you value most. If you prefer the flexibility of trading intraday and favor lower expense ratios in most instances, go with ETFs. If you worry about the impact of commissions and spreads, go with mutual funds.
If you're looking for an easy solution to investing, ETFs can be an excellent choice. ETFs typically offer a diversified allocation to whatever you're investing in (stocks, bonds or both). You want to beat most investors, even the pros, with little effort.
Stock-picking offers an advantage over exchange-traded funds (ETFs) when there is a wide dispersion of returns from the mean. Exchange-traded funds (ETFs) offer advantages over stocks when the return from stocks in the sector has a narrow dispersion around the mean.
Low Liquidity
If an ETF is thinly traded, there can be problems getting out of the investment, depending on the size of your position relative to the average trading volume. The biggest sign of an illiquid investment is large spreads between the bid and the ask.
Market risk
The single biggest risk in ETFs is market risk. Like a mutual fund or a closed-end fund, ETFs are only an investment vehicle—a wrapper for their underlying investment. So if you buy an S&P 500 ETF and the S&P 500 goes down 50%, nothing about how cheap, tax efficient, or transparent an ETF is will help you.
ETFs offer numerous advantages including diversification, liquidity, and lower expenses compared to many mutual funds. They can also help minimize capital gains taxes. But these benefits can be offset by some downsides that include potentially lower returns with higher intraday volatility.
In many ways mutual funds and ETFs do the same thing, so the better long-term choice depends a lot on what the fund is actually invested in (the types of stocks and bonds, for example). For instance, mutual funds and ETFs based on the S&P 500 index are largely going to perform the same for you.
Index investing pioneer Vanguard's S&P 500 Index Fund was the first index mutual fund for individual investors.
How long should you stay invested in ETF?
Hold ETFs throughout your working life. Hold ETFs as long as you can, give compound interest time to work for you. Sell ETFs to fund your retirement. Don't sell ETFs during a market crash.
ETF | Assets Under Management | Expense Ratio |
---|---|---|
Vanguard Information Technology ETF (VGT) | $70 billion | 0.10% |
VanEck Semiconductor ETF (SMH) | $16.3 billion | 0.35% |
Invesco S&P MidCap Momentum ETF (XMMO) | $1.6 billion | 0.34% |
SPDR S&P Homebuilders ETF (XHB) | $1.8 billion | 0.35% |
You expose your portfolio to much higher risk with sector ETFs, so you should use them sparingly, but investing 5% to 10% of your total portfolio assets may be appropriate. If you want to be highly conservative, don't use these at all.
Nearly all leveraged ETFs come with a prominent warning in their prospectus: they are not designed for long-term holding. The combination of leverage, market volatility, and an unfavorable sequence of returns can lead to disastrous outcomes.
The low investment threshold for most ETFs makes it easy for a beginner to implement a basic asset allocation strategy that matches their investment time horizon and risk tolerance. For example, young investors might be 100% invested in equity ETFs when they are in their 20s.
Exchange-traded fund (ticker) | Assets under management | Expenses |
---|---|---|
Vanguard Dividend Appreciation ETF (VIG) | $78.2 billion | 0.06% |
Vanguard U.S. Quality Factor ETF (VFQY) | $324.3 million | 0.13% |
SPDR Gold MiniShares (GLDM) | $6.8 billion | 0.10% |
iShares 1-3 Year Treasury Bond ETF (SHY) | $24.8 billion | 0.15% |
Leveraged ETF prices tend to decay over time, and triple leverage will tend to decay at a faster rate than 2x leverage. As a result, they can tend toward zero.
If Vanguard ever did go bankrupt, the funds would not be affected and would simply hire another firm to provide these services.
An ETF with a low risk rating can still lose money. ETFs do not provide any guarantees of future performance. As with any investment, you might not get back the money you invested.
There are a few reasons why ETFs generally die. Low assets under management, high fees, poor performance, and short track records are closely associated with the probability of closure.
Are Fidelity ETFs worth it?
ETFs can offer lower operating costs than traditional open-end funds, flexible trading, greater transparency, and better tax efficiency in taxable accounts. As with all investment choices there are elements to review when making an investment decision.
Symbol | Name | 5-Year Return |
---|---|---|
IUS | Invesco RAFI Strategic US ETF | 14.75% |
OEF | iShares S&P 100 ETF | 14.73% |
SPHB | Invesco S&P 500® High Beta ETF | 14.58% |
SPYG | SPDR Portfolio S&P 500 Growth ETF | 14.40% |
If you're paying fees for a fund with a high expense ratio or paying too much in taxes each year because of undesired capital gains distributions, switching to ETFs is likely the right choice. If your current investment is in an indexed mutual fund, you can usually find an ETF that accomplishes the same thing.
At least once a year, funds must pass on any net gains they've realized. As a fund shareholder, you could be on the hook for taxes on gains even if you haven't sold any of your shares.
Owning both types of funds may be a smart strategy as each can offer protection and opportunity. For example, if you own a passively managed ETF, also buying an actively managed mutual fund may offer you some upside potential beyond that of the index being tracked.