ETFs vs Mutual Funds

An ETF (Exchange Traded Fund) is a form of mutual fund. There is frequent discussion in the forum on the comparative merits of ETFs and mutual fund. User livesoft has offered a succinct summary below.

Pros of ETFs:

1. Generally lower expense ratios and can purchase less than the minimums needed for some mutual funds.
2. A good broker like WellsFargo or Fidelity make tax-loss harvesting and bookkeeping trivial since one can easily use specific share id (but they can do this with mutual fund shares as well).
3. Can use limit orders so you know exactly what you are paying.
4. Can purchase during the day at known prices without waiting for the close of the market session.
5. Asset classes available that an entity like Vanguard does not have in their mutual funds.
6. One can take advantage of occasional anomalies and purchase shares at a lower than expected price.
7. No frequent trading restrictions.

Cons of ETFs:

1. Some brokers charge a commission. Not a problem with brokers which do not charge a commission.
2. The bid-ask spread confuses some people, but we have seen it can be small or one can be taken advantage of.
3. No real way to get a fair price when the market is closed.
4. Must buy integral number of shares ... cannot typically buy fractional shares (though some brokers allow this, but they are not no-commission brokers).
5. Automatic investment is problematic. Your broker may have this functionality, but would you trust their prices? (Do not confuse automatic investment with automatic re-investment of distributions.)
6. Some possible friction when tax-loss harvesting since one usually sells one fund and then buys another. (It is possible to buy first and double-up, then sell later. This can be done with mutual funds as well.)
7. One can stupidly submit orders to sell when the market is closed or use stop-loss orders that get taken advantage of. Or one can make other errors entering orders.

Pros of mutual funds:

1. Can buy fractional shares; all your money goes into shares without leftovers.
2. Automatic investment is easy.
3. Trades execute at end-of-day net asset value.
4. Exchange from one fund to another has no friction since both sell & buy done at end-of-day NAV.
5. Can submit orders when the market is closed. You will get a fair price at the next available NAV.
6. Dividends re-invested the same day they are paid at NAV.

Cons of mutual funds:

1. Expense ratios can be (not always) higher than corresponding ETF.
2. No intraday transactions.
3. Lack of some asset classes without excessive fees.
4. Some funds have trading restrictions (cannot re-buy after selling for NN days).

General remarks

• Both mutual funds and ETFs allow free automatic re-investment of distributions. It is really a broker function --- not a function of the investment.
• Both ETFs and mutual funds can be tax efficient ... or not.
• Each investor will need to assign value to the advantages important to them and subtract value of the disadvantages important to them. ETFs are not a slam dunk. Neither are mutual funds.

Further reading

• The basics of ETFs: A primer for the perplexed is Vanguard's introduction to the topic.
• The Choice Between ETFs and Conventional Index Fund Shares is Vanguard's in-depth look.

See also

• Should I use mutual funds or ETFs?

 

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Wiki article link: [url=http://www.bogleheads.org/wiki/ETFs_vs_Mutual_Funds]ETFs vs Mutual Funds[/url]