| Since their introduction in 1993, Exchange-Traded | | | | (including dividend reinvestments, in some cases) |
| Funds (ETFs) have steadily taken market share | | | | and must also consider the bid/ask spread, or the |
| from index-based mutual funds. Today they | | | | difference between what a buyer is willing to pay |
| account for 40% of the index fund marketplace | | | | for a security and the seller's offer price. |
| and show no signs of slowing down. These | | | | Commissions are typically between $5 and $25 |
| baskets of securities that passively track an index | | | | per trade, while bid/ask spreads vary based on |
| (in most cases) and trade throughout the day like | | | | an ETF's liquidity. Among a popular basket of |
| stocks have profoundly impacted the investment | | | | domestic and international ETFs, the average bid |
| industry. Active traders take advantage of the | | | | ask spread cost is typically between .01% and |
| stock-like features of ETFs: limit order purchasing, | | | | .04% of the transaction value. Investors must |
| shorting, and options. For the index investor, the | | | | exercise caution when trading spreads are more |
| low ongoing costs of ETFs represent an | | | | than a few cents as an ETF's market price can |
| opportunity to squeeze greater returns from a | | | | deviate significantly from the underlying value of |
| buy-hold-rebalance portfolio. | | | | its holdings (NAV). |
| It's important to keep the ETF-mutual fund | | | | Many would argue that the mutual fund structure |
| decision in perspective. Your choice of investment | | | | encourages good investing behavior. For instance, |
| vehicle will have much less of an impact on your | | | | commission-free trading facilitates a dollar-cost |
| portfolio's long-term performance than your ability | | | | averaging strategy, or the practice of investing a |
| to build and faithfully implement a risk-appropriate | | | | fixed dollar amount on a regular schedule in order |
| asset allocation plan. That being said, if you | | | | to purchase a greater number of low-priced |
| already have a long-term investment plan and you | | | | shares. An investor who doesn't pay transaction |
| wish to maximize your chances of achieving your | | | | costs also doesn't hesitate to perform a |
| financial goals, this article can help you determine | | | | rebalancing trade when his portfolio deviates from |
| whether ETF investing is right for you. | | | | a risk-appropriate allocation; a transaction cost |
| ETF Advantages | | | | might cause him to delay this important action. |
| The most glaring advantage of ETFs over mutual | | | | Prominent indexing advocates like John Bogle and |
| funds is their lower expense ratios. Comparing a | | | | Warren Buffett have voiced concern that ETF |
| popular basket of domestic and international index | | | | trading could cause investors to stray from a |
| funds with their ETF counterparts, the ETFs have | | | | long-term, disciplined investing approach. |
| an average expense ratio advantage of .11% | | | | Conclusion |
| annually. This advantage obviously becomes more | | | | Your unique circumstances and priorities can help |
| meaningful when a large initial investment grows | | | | you determine which investment vehicle offers |
| undisturbed over several years. While ETF-like | | | | you the greatest chance of financial success. For |
| expense ratios are available through exclusive | | | | many index investors, cost considerations drive |
| mutual fund share classes like Vanguard's Admiral | | | | the majority of investment decisions. Vanguard's |
| Class ($100,000 investment generally required), | | | | ETF-Mutual Fund comparison tool can help you |
| ETFs clearly have lower ongoing costs than most | | | | weigh the upfront cost advantage of mutual |
| comparable mutual funds. | | | | funds versus the low ongoing expenses of ETFs. |
| ETFs are also more tax efficient than mutual | | | | This tool generates hypothetical returns for |
| funds. The process of creating and redeeming | | | | Vanguard's ETF and mutual fund share classes |
| new shares "in-kind" allows most ETFs to unload | | | | based on your initial investment, expected holding |
| low cost-basis shares and theoretically eliminate | | | | period, trading frequency and commission rate. Be |
| unwanted capital gains distributions. Additionally, for | | | | sure to consider future Admiral Share eligibility |
| tax loss harvesters, the vast number of ETF | | | | when analyzing the output. |
| choices allows for efficient swapping of | | | | Like many investors, you may find that cost |
| capital-losing funds for suitable alternatives. | | | | considerations alone don't produce a clear winner. |
| Finally, ETFs have a significant advantage in trading | | | | If ETFs are an obvious choice for some |
| flexibility. Since ETFs are traded through brokers | | | | investments while mutual funds are best for |
| instead of fund companies, an investor can buy | | | | others, look to non-cost factors to make your |
| an ETF on any platform at any time of day. Daily | | | | decision. For instance, if you value trading flexibility |
| holdings reports and up-to-the-minute estimates | | | | and fund variety, an ETF portfolio through an |
| of underlying fund value (Intraday Indicative Value, | | | | online brokerage firm may be a logical choice. |
| or IIV) give ETF shoppers the transparency they | | | | Alternatively, an appreciation for simplicity or the |
| need. Although trading costs must be considered, | | | | need for philosophical alignment may lead you to |
| the fund minimums and redemption fees often | | | | do business with a single fund company. A true |
| associated with mutual funds do not apply to | | | | cost-minimizer who can manage an added layer |
| ETFs. Additionally, the ability to specify trading | | | | of complexity in his portfolio may decide to split |
| prices through limit orders can help to maintain a | | | | his investments among multiple account providers |
| precise allocation. | | | | (e.g., a tax-sheltered mutual fund account with |
| Mutual Fund Advantages | | | | Vanguard and a taxable account with a low-cost |
| While ETFs can boast of low ongoing expenses, | | | | online brokerage firm for ETF purchases). |
| mutual funds have a clear advantage in | | | | Whether you decide on ETFs, mutual funds, or a |
| transaction costs. In general, mutual funds can be | | | | mix of both in your portfolio, it's important to |
| purchased commission-free through their fund | | | | keep this decision in perspective. Your ability to |
| company with relatively low investment minimums | | | | faithfully maintain a diversified, risk-appropriate |
| and automatic dividend reinvestment. On the | | | | asset allocation will play a much larger role in |
| contrary, ETF purchasers must pay a trading | | | | determining your financial success than your |
| commission for each brokerage transaction | | | | choice of investment vehicle. |