What are the advantages and disadvantages of investing in an ETF vs a mutual fund?
ETFs often generate fewer capital gains for investors than mutual funds. This is partly because so many of them are passively managed and don't change their holdings that often. However, ETFs also have a structural ability, called the in-kind creation/redemption mechanism, to minimize the capital gains they distribute.
ETFs often generate fewer capital gains for investors than mutual funds. This is partly because so many of them are passively managed and don't change their holdings that often. However, ETFs also have a structural ability, called the in-kind creation/redemption mechanism, to minimize the capital gains they distribute.
Exchange-traded funds (ETFs) take the benefits of mutual fund investing to the next level. ETFs can offer lower operating costs than traditional open-end funds, flexible trading, greater transparency, and better tax efficiency in taxable accounts.
The single biggest risk in ETFs is market risk. Like a mutual fund or a closed-end fund, ETFs are only an investment vehicle—a wrapper for their underlying investment.
Mutual funds come with many advantages, such as advanced portfolio management, dividend reinvestment, risk reduction, convenience, and fair pricing. Disadvantages include high fees, tax inefficiency, poor trade execution, and the potential for management abuses.
There are many ways an ETF can stray from its intended index. That tracking error can be a cost to investors. Indexes do not hold cash but ETFs do, so a certain amount of tracking error in an ETF is expected. Fund managers generally hold some cash in a fund to pay administrative expenses and management fees.
The choice comes down to what you value most. If you prefer the flexibility of trading intraday and favor lower expense ratios in most instances, go with ETFs. If you worry about the impact of commissions and spreads, go with mutual funds.
Key Takeaways. Exchange-traded funds (ETFs) have become incredibly popular investments for both active and passive investors alike. While ETFs provide low-cost access to a variety of asset classes, industry sectors, and international markets, they do carry some unique risks.
- 1) Market Risk. The single biggest risk in ETFs is market risk. ...
- 2) "Judge A Book By Its Cover" Risk. The second biggest risk we see in ETFs is the "judge a book by its cover" risk. ...
- 3) Exotic-Exposure Risk. ...
- 4) Tax Risk. ...
- 5) Counterparty Risk. ...
- 6) Shutdown Risk. ...
- 7) Hot-New-Thing Risk. ...
- 8) Crowded-Trade Risk.
If you're paying fees for a fund with a high expense ratio or paying too much in taxes each year because of undesired capital gains distributions, switching to ETFs is likely the right choice.
What happens if ETF goes bust?
Liquidation of ETFs is strictly regulated; when an ETF closes, any remaining shareholders will receive a payout based on what they had invested in the ETF. Receiving an ETF payout can be a taxable event.
Leveraged ETF prices tend to decay over time, and triple leverage will tend to decay at a faster rate than 2x leverage. As a result, they can tend toward zero.
But can a leveraged ETF go negative? No. If you own a leveraged ETF you can't lose more than your initial investment amount. You would never be liable for more than you invested; in a sense, the amount you could lose is capped.
Disadvantages of Investing in Mutual Funds
Lack of Control: Investors have limited control over specific investments made by the fund manager. Market Risk: The value of mutual funds can go up and down, just like the stock market. This means that you may lose money if you invest in a mutual fund.
Downside risk is an estimation of a security's potential loss in value if market conditions precipitate a decline in that security's price. Downside risk is a general term for the risk of a loss in an investment, as opposed to the symmetrical likelihood of a loss or gain.
How are ETFs and mutual funds different? How are they managed? While they can be actively or passively managed by fund managers, most ETFs are passive investments pegged to the performance of a particular index. Mutual funds come in both active and indexed varieties, but most are actively managed.
Holding period:
If you hold ETF shares for one year or less, then gain is short-term capital gain. If you hold ETF shares for more than one year, then gain is long-term capital gain.
| ETF | Assets under management | Expense ratio |
|---|---|---|
| Invesco QQQ Trust (ticker: QQQ) | $244 billion | 0.2% |
| VanEck Semiconductor ETF (SMH) | $14 billion | 0.35% |
| Consumer Discretionary Select Sector SPDR Fund (XLY) | $19 billion | 0.09% |
| Global X Uranium ETF (URA) | $3 billion | 0.69% |
Should you invest in ETFs? Since ETFs offer built-in diversification and don't require large amounts of capital in order to invest in a range of stocks, they are a good way to get started. You can trade them like stocks while also enjoying a diversified portfolio.
You can hold ETFs as long as you want. Allow compound interest to work for you over time. However, you should avoid selling ETFs when the market is down since you can miss out on the potential to gain money when the market recovers.
Should you hold ETFs long term?
Finding the best long-term ETFs can help reward you if you buy and hold, allowing you to compound your money over time. Even small differences in returns, just a few percent annually, can create an amazing improvement in your total wealth.
The VanEck Digital Transformation ETF (DAPP) surged nearly 190.26% by December 12th, followed by the Valkyrie Bitcoin Miners ETF (WGMI) with a 185.23% gain, and the Invesco Alerian Galaxy Crypto Economy ETF (SATO) rounding out the top three with a 179.79% increase.
If you don't want to put a lot of effort into managing your investments, then S&P 500 ETFs are a good solution. But if you're willing to do the work, then you might do even better in the long run with a portfolio of hand-picked stocks (although, the odds are against you).
Bottom line. ETFs make a great pick for many investors who are starting out as well as for those who simply don't want to do all the legwork required to own individual stocks. Though it's possible to find the big winners among individual stocks, you have strong odds of doing well consistently with ETFs.
| Symbol | Name | 5-Year Return |
|---|---|---|
| XSD | SPDR S&P Semiconductor ETF | 25.47% |
| IYW | iShares U.S. Technology ETF | 25.33% |
| SPXL | Direxion Daily S&P 500 Bull 3X Shares | 24.54% |
| UPRO | ProShares UltraPro S&P500 | 24.25% |
