Dear Young Investor, you are wondering about ETF’s (I know you are) and want to know if these are a better investment option versus investing in a mutual fund. And of course the answer is unclear. There are pros and con’s to both and below is a quick highlight of the two investment vehicles. But first a quick look…..
ETF’s: no minimum, price per share is easy to access, trades like a stock, low cost investment, potential tax advantage, better for equity exposure than for bond exposure, no automatic reinvestment of dividend income.
Mutual Funds:More industry/sector specific investment options, easy reinvestment, can buy partial shares, valuation only after markets close, higher expense ratio vs. ETF’s, potential tax disadvantage.
What is an exchange-traded fund (ETF) and how is it different than a mutual fund? In both a mutual fund and an ETF you own a small part of a larger pool of assets. The difference is that with a mutual fund, you own a small part of each stock or bond that is in the fund. For an ETF, you own a part of the Trust that holds the securities. So, if we liken the fund to a pizza, with the mutual fund you own a slice of the actual pizza and the slice has a bit of each ingredient. With the ETF, you own 25 cents worth of the pizza. You can’t hold the slice, but the pizza gets sold, you’ll get your part.
For the smaller investor, ETF’s are a great vehicle. There can be a tax benefit and they trade like stocks on exchanges so you have some flexibility. And you know the price readily. With mutual funds you don’t know that value of the shares until after the close of the trading day (which I don’t think is that big of a deal – we aren’t day traders, nor are we market timers). ETF’s generally have a lower expense ratio. And ETF’s have no minimum purchase requirement while many mutual funds have a $1,000 to $2,500 minimum investment (or higher), and this is prohibitive when you’re just starting to save and haven’t built up a lot of investment funds.
ETF’s are mainly equity investment vehicles, so you would have to get bond exposure through the use of mutual funds (or actual bonds). The problem with holding an actual bond is that it is going to be a relatively small holding, so if you go to sell it, you’ll get killed on the exit price. But if you hold it to maturity, it’s a great way to go as you know with certainty that you’ll get face value at when the bond matures. No surprises.
Let’s talk reinvestment. Scenario 1: you buy a mutual fund and reinvest all the dividend income. What does this mean? Well, the securities in the fund may pay dividends and when that happens, those dividends get reinvested in the fund ~ you buy more shares. With mutual funds you can buy partial shares, so this is easy and you don’t have to make as many decisions each quarter. Scenario 2: you buy shares of an ETF. You get the dividends and they go to cash. Then you get some cash build up and you have to decide what to do with that cash.
Over all, I think owning ETF’s is cheaper and easier ~ and in this case cheap and easy is what we want.
Ok, this is boring. Let’s move on to what to actually buy – Next Blog
Connie
Invest Gen Y 