Exchange traded funds are a type of securities listed and traded on a stock exchange almost like a stock. As far as the investment strategy goes, traditional ETFs track indices and are a great way to diversify your investment. Some people confuse them with mutual funds. Mutual funds carry redemption fees, a charge not present with ETFs.
Mutual funds also have restrictions on selling and buying during day trade, while ETFs can be practically sold or bought like a stock in the market. Here are a few reasons why you should consider investing in ETFs.
Low cost
Although there is no assurance that you will get an ETF with low cost fees, the fees are comparatively lesser most of the times than open ended mutual funds. They also do not charge 12B-1 fees. This is an operational fee levied for distribution or annual marketing, and is part of a mutual fund’s expense.
Tax efficiency
One of the best things about investing in ETFs is the tax efficiency they allow you. You have to pay tax on the gains from selling of ETFs that appreciated in value. But in case of mutual funds, since the buying and selling is happening very frequently (being conducted by the fund managers), the fund on the whole accrues a significant tax liability, which is passed on to you. In mutual funds, you have no control on when you would like to pay tax, as you have in the case of ETFs.
Flexibility
You get a greater deal of flexibility with ETFs than with mutual funds. You have the flexibility of actively (intraday trading) or passively (buy and hold) managing your investment. If you actively trade, you can actually earn a tidy profit by taking advantage of the intraday fluctuations, but this is usually risky as the tide can turn the other way too. If you simply hold your investment, then you will make money over a period of time, even if not in the shorter term. You can buy and sell ETFs at any time during trading hours, whereas mutual funds are only priced at the end of the day. With ETFs, you also don’t have to pay any penalties on redemption fee.
A diversified approach to investment is recommended to ensure that you do not take too many or too few risks. If you have a comprehensive investment strategy in mind, then you ought to invest in ETFs, as you will get the scope of diverse options at minimal cost.