ETFs are a good option for investors who want to diversify their portfolio but don’t really know how and what to invest in. Although mutual funds are a good diversification choice, ETFs bring some unique advantages to the table, which make them doubly attractive.
How ETFs Work:
Understanding how ETFs work can help us comprehend some of the main advantages they offer. ETFs are Exchange Traded Funds that follow a specific index. For example, the OIH is an ETF that follows the OSX Oil index, and gains value when the OSX moves up. With an ETF, you get a readymade, well diversified portfolio in one simple purchase transaction. Remember, an ETF will match the index it is based on but is not designed to stupendously out perform the sector it is tracking.
ETFs vs MFs
1.ETFs, as we now know, follow a certain index. This is why they don’t need to be managed by expert fund managers, which in turn lowers the costs. This cost benefit is passed on to you in the form of lower fees and charges. A mutual fund will typically charge you higher fund management fees and other charges, which may significantly increase if the fund is an actively managed one.
2.ETFs trade in the open market during trading hours. This gives you a wider window of opportunity to take quick advantage of spikes and drops in the market. Simple, non-complex transactions allow you to complete trades within the shortest possible time.
3.Your tax liability is lower with an ETF when compared to investment in a mutual fund. In a mutual fund, trades occur often and the tax liability accrued is substantial during periods of massive sales. These costs are passed on to the share holders of the fund on an ongoing basis. With an ETF, you need to pay capital gains tax only when you sell the fund.
4.The ETF is a more transparent investment vehicle than a mutual fund. The ETF designers typically post list of assets everyday, which gives you an opportunity to keep track of exactly where your hard earned money is going. If you don’t like the investment strategy, simply pull out with one simple transaction.
5.Many stock-like trading options such as shorting, call and put options are possible with ETFs but not with mutual funds. These allow the ETF investor to get the most out of his investment by using his judgment and knowledge of the market’s volatility to manipulate his holdings. This range of flexibility is impossible with a mutual fund investment.