5 Reasons Managed Mutual Funds Never Beat ETFSon Friday, 31 August 2012. Posted in ETFs, Investments
A lot of expats these days have bought their mutual funds years ago and unbeknown to them, there are other, possibly more profitable and safer options out there. We spend most of our time chasing down taxis and dodging music blasting scooters to give a second thought to our own investments, much less an alternative. But give a chance, even a blind man can see that actively managed mutual funds are no longer fashionable amongst the investors in the know.
The first ETF (exchange traded fund) created in 1993 might have spelled the end of mutual funds as we know it. In recent years, there has been exponential growth in the number of ETF’s and the amount of investor dollars pouring into them. There are good reasons for this increased popularity and I will outline 5 reasons why.
• ETF’s are Cheaper
In general, most index ETF’s are much more inexpensive than your Fidelity Managed Fund. Annual fees can be as low as .04% for ETF’s and average 1.4% (Morningstar) for Managed Funds. As you can see, this can make a big difference in your returns. Also, there is no minimum for investing in an ETF where there is usually at least a $1,000 minimum on the cheapest mutual funds. This can be beneficial for a new young investor trying to build wealth for his future.
ETF’s are designed to follow a particular index not outperform it therefore only small changes are needed. On the other hand, fund managers regularly make trades and can rack up large management fees, which you pay for in the end. These expenses can eat into returns and is part of the reason why they do not outperform index ETF’s.
• Tax advantages
ETF’s are different to managed funds in that they are sold from one investor to another whereas with a managed fund you are buying from a fund manager such as Vanguard. This is significant in the redemption stage when an investor wants to sell his stake in a managed fund. To do this, management might need to sell some underlying assets to pay for this which could trigger tax events. This constant rebalancing by investors can eat into returns. Unless you are making Warren Buffett sized trades then rebalancing your portfolio of ETF’s will have no effect to the other guys’ portfolio.
• Increased Flexibility
Unlike mutual funds, ETFs can be shorted if investors anticipate a downward movement in a particular index or. Even though short selling is a risky strategy, it is a useful tool for experienced and nimble investors. Also, you can buy options on most traded ETF’s with the bid and ask quite tight. This gives you more options to maximize your return. On the contrary, mutual funds only have the choices of buy, sell or don’t buy to begin with. It’s kind of like playing basketball with one hand while your competitors are using both hands.
One of the great things about ETF’s is that you see what you get. There is a daily disclosure of all the ETF’s holdings. In contrast, a mutual fund only is required to report 4 times a year. This means an investor could get stuck holding a loser and not even know it until the next disclosure but by that time it could be impossible to get out without a major loss. Access to information quickly is very valuable and a must have for any investor.
Overall, you will not see the end to mutual funds for a long time but ETF’s are catching up fast. As people become aware of the advantages and understand them more clearly, then you will see a shift from mutual funds to ETF’s. This is by no means a hint to go run out and buy an ETF. Only utilize these if it is the right product for you and if it will work with your goals.