Continue the ETFs course with module 2, which compares the benefits of investing in ETFs and mutual funds and outlines key concepts to consider before investing.
HOW ETFs AND MUTUAL FUNDS ARE USED
Financial professionals use ETFs and mutual funds to pool investors’ money together and invest it across stocks, commodities, bonds, or other assets. ETFs and mutual funds are commonly used among investors.
CHOOSING THE RIGHT
INVESTMENT VEHICLE
Below is a breakdown of the advantages and drawbacks of ETFs and mutual funds, and how they compare to individual stocks. Financial professionals should consider mapping their clients’ needs against the benefits of each investment vehicle to determine the best approach when building a portfolio.
| Active mutual funds | iShares ETFs | Stocks | |
|---|---|---|---|
| Diversified
Many stocks or bonds in a single fund |
 |
 |
|
| Traded on exchange throughout trading day
Buy and sell whenever the market is open |
|
|
|
| Intraday pricing
Live pricing throughout the course of the trading day |
|
|
|
| Management fees
Annual cost of a professionally managed fund |
|
|
|
| Transaction fees
Costs associated with buying or selling (e.g., mutual fund sales loads, brokerage commission fees) |
|
|
|
| Index tracking
Seek to track the return of a market index |
|
THINGS TO CONSIDER
BEFORE INVESTING
1) Compare investment strategies
Investments can either be managed actively, like most mutual funds, or can be indexed, like most ETFs. Active funds seek to outperform market indexes whereas index funds are measured by their ability to match their performance to an established index, like the S&P 500.
Fund managers study the market and draw on their investment experience and expertise to try to maximize the fund’s performance but in turn, could result in higher fees than an index fund.
2) Consider the impact of fees
There are two main costs to consider with investments: Transaction fees and the fund’s expense ratio.
Other fees that make up operating costs can include custodial services, recordkeeping, legal expenses, acquired fund fees and expenses (if the fund invests in other funds), accounting and auditing fees, or a marketing fee (called a 12b-1 fee). Operating expenses are taken directly out of the fund resulting in a lower return to the investors. In general, funds that pursue an active investment strategy will have higher operating costs than indexed funds because they are seeking excess return than the index.
3) Remember to evaluate taxes
Most ETFs incur fewer capital gains given that they are indexed investments and typically trade less frequently than most active mutual funds.
When mutual fund investors redeem shares from the fund, the fund manager will often sell fund securities to honor these redemptions. This process triggers capital gain distributions for other investors who make up the pooled investment. Because investors can buy and sell ETFs on an exchange, the ETF manager does not have to sell holdings to meet investor redemptions, which limits the capital gains created.
THINK DIFFERENTLY
Compared to mutual funds, ETFs are simpler, more cost-effective and can generally be lower risk. They offer immediate visibility and flexibility in trading at any time during trading hours. If an investor currently holds mutual funds in their portfolio, ETFs can be a great addition as they can offer potentially more predictable return.
This concludes the second module of the ETF course. Read the next module, which determines what to consider when investing in ETFs, to continue the course.
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