ETFs vs Mutual Funds: Why Are ETFs Being Preferred over Mutual Funds?

Question: My name is Ruskin Fernandes. Me and wife are both working  professional. She is currently working in a bank and she advised me to start ETFs instead of buying mutual funds. She thinks ETFs are low cost as compared to mutual funds. Want to know what are the main reasons and why people think ETFs are more preferred against mutual funds.

Answer: The exchange traded fund industry is wooing more investors from the mutual funds sector. This is because most investors see a low-cost, flexible, and tax efficient investment vehicle in ETFs. This explanation is validated by the fact that ETF assets between Sept. 2011 and July 2013, have surged to nearly 60 percent. On a comparative basis, mutual funds have surged by 36 percent.

Financial experts are of the view that ETFs and mutual funds are no different investment vehicles though they are made out to be so. All said and done both ETFs and mutual funds are diversified and low-cost professionally managed investment portfolio. So, what is the underlying difference between the two?

Intra-Day Trades

Unlike mutual funds that are priced at the end of daily trading, ETFs, like normal stocks are traded throughout the day. This makes ETFs a lot more flexible. However, this flexibility can be leveraged only if one has the right kind of knowledge on how ETFs are traded, using limit orders and with a complete understanding of the costs involved. The intra-day tradability feature can be used to control movements in more than one market segment.

Cost Efficient

Another distinct advantage is that ETFs don’t require fees to buy or redeem assets. Investors only have to shell out the commission fee on trades along with yearly expenses that is required to maintain ETFs. Having said this, it needs to be mentioned that there are online brokerage platforms that offer commission-free trades on a number of ETFs. So maintaining ETFs entails lower operating expenses than mutual funds. On a comparative basis with ETFs investors can have more control over their investments.

Are ETFs or Mutual Funds More Tax Efficient

Though ETFs and mutual funds are tax-efficient, in most cases but ETFs hold the edge. ETFs ensure tax efficiency by allowing the investment to steer clear of capital gains through redemptions. ETFs are continuously bought and sold in an effort to beat the market. So there is little chance for an ETF to make capital gains.

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