As an investor, if you prefer your funds to have intraday liquidity, reduced costs, transparency, tax efficiency, and greater flexibility then exchange-traded funds are for you. These are some of the advantages of exchange-traded funds offer over traditional mutual funds.
- Intraday Liquidity: This is the defining characteristic of exchange-traded funds that allow them to be bought or sold at any time on a trading day. A mutual fund would have you waiting till trading closes which could be an expensive delay. Sometimes stocks rise to a high premium during a trading day and although exchange-traded funds have a Net Asset Value (NAV) they don’t impose strict adherence to those values, unlike mutual funds. This allows an investor disposes of his holdings at the right price hence making a profit.
- Reduced costs: Exchange-traded funds tend to have lower expense ratios than similar mutual funds because their purchase occurs through a brokerage account which already has all records and paperwork. The brokerage firm bears the processing expenses. Mutual funds would have the mutual fund company handle all your paperwork which adds up to the cost. This is the case most of the time. Exchange traded funds like SPDR S&P 500 ETF, iShares Core MSCI EAFE ETF, Vanguard FTSE Emerging Markets, SPDR Gold Trust and iShares Core S&P Small-Cap ETF come in packages and are bought by opening a brokerage account in that firm. Any transaction done with that holding is transferred with the paperwork of the account thereby reducing stress.
- Transparency: Exchange-traded fund holdings are disclosed regularly and frequently, unlike mutual funds which disclose their holdings quarterly, with a 30-day lag. This allows investors in exchange-traded funds to have an idea of how their holdings or assets stand.
- Malleability: Exchange-traded funds are characteristically similar to stocks and therefore not as rigid as mutual funds. They allow the investor a variety of options in utilizing them; one can write options against them, short-term and buy them on margin.
- Greater Profit holding Capacity: Due to their increased liquidity, exchange-traded funds can be sold quickly at a premium ensuring gain and then the capital and dividends can be used to repurchase other exchange-traded fund holdings. This is a great strategy used to increase money and to retain profit. It ensures that the profit made is retrieved and secured before the fund drops in price once again.
Exchange-traded is also one of the most tax efficient methods of holding money and assets due to particular characteristics absent in other funds.
These above-listed characteristics define the advantages of exchange-traded funds and allow them to remain one of the most attractive investment options. They do have some extra expenses and downsides but most of these are unavoidable and can be mitigated against.
- Commissions: These are paid on the purchase or redemption of any security. And because exchange-traded funds allow you to run more intraday trading you, therefore, pay more commission fees. Commissions depend on the broker and are not a function of the transactions run on the exchange-traded funds but because most brokers will commission transactions and the major advantage of exchange-traded funds is their ease of intraday transactions there is the following increase in the amount of money paid by owners in form of commission. Although there has arisen a number of commission-free exchange-traded funds in places like Etrade, Charles Schwab, and TD Ameritrade.
- Spreads: This is the difference between the selling price and the purchasing price of a security. As an investor, you have to pay the spread and this can be quite high if a large disparity is present between cost and selling price.
- Premiums and Discounts: Mechanisms exist which are to ensure that when buying or selling a mutual fund at the end of a day you get a fair price; these mechanisms set a ‘Net Asset Value’ at which trading occurs. These mechanisms exist in exchange-traded funds but are not foolproof and can lead to you trading at a premium or discount to the set NAV.
- Illiquidity: Not all exchange-traded funds trade regularly, in fact, some rarely trade at al. It is therefore imperative that as an investor, one observes a chosen exchange-traded fund closely before investing to prevent your money getting stuck. As was mentioned before, do your homework before investing.