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Mutual Funds vs. ETF’s

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There has been a lot of publicity in recent years regarding ETF’s, (exchange traded funds) and how they are potentially a better alternative to mutual funds.  However, I feel that much of the information out there is somewhat confusing and misleading.  I want to stress that in my practice, I don’t favor one type of investment over another as each individual investor’s goals and objectives are different requiring a custom made strategy for every situation.

 

As such, my goal in this discussion is to be informative and unbiased as to the pros and cons of mutual funds and exchange traded funds.

 

Let’s start with mutual funds.  Mutual funds came into existence with the Investment Company Act of 1940.  It is important to note that there are some mutual funds that were created back in 1940 that are still in existence today.  The point being is that both mutual funds as well as exchange traded funds technically do not mature.  They are designed to theoretically be in business in perpetuity.  So what exactly is a mutual fund?  In essence it is a basket of securities that is held by an investment management company that acts as custodian in the buying and selling of those securities.  There are many objectives that a mutual fund can be managed to such as growth, income, tax sheltered income or relative stability of principal.  The objective of the fund structure is to bring together a large number of investors with the same investment goal and take advantage of their combined purchasing power to enable proper diversification which is a cornerstone of a well planned investment strategy.  The portfolio manager does all of the buying and selling of securities as well as monitoring the markets to maintain the best mix of securities.  The main advantages of a mutual fund are as follows, professional management and diversification without having to commit large sums of money.

 

Exchange traded funds, (ETF’s) are similar to mutual funds in that there is also a basket of securities that is overseen by a portfolio manager.  However, this is generally where the similarities end.  The reason being is that ETF’s have a portfolio that typically mimics a particular index such as the Standard and Poor’s 500 index.  This index, for example, seeks to track the price movement of 500 selected stocks on the New York stock exchange.  The portfolio manager’s main responsibility in this case is to keep the fund’s assets in line with the index that it tracks.  This job is considerably simpler than a mutual fund manager’s job and as a result the management fees on an ETF are generally lower than that of an actively managed mutual fund.

 

Another difference between mutual funds and ETF’s is that they trade differently on the exchanges.  ETF’s trade like stocks with what’s known as intra-day pricing or share prices that can change throughout the trading session.  Mutual funds price per share however is calculated and fixed once per day right after the market closes.  In this case the investor will not know what price the shares are at until the next day.  While this may not sound like much of a difference, it actually is.  ETF’s became popular in part due to the fact that they can be bought or sold on a seconds notice, thus giving the investor a tremendous amount of flexibility in managing their portfolio.

 

There is also the issue of fees to own these securities.  Mutual funds can charge the investor what is called a load or fee to buy the shares.  Generally there is not a load to sell the shares and the investor usually has free exchange privileges   among other funds in the same family of funds.  ETF’s, like stocks, have a commission to buy as well as a commission to sell.  This can get expensive in either case if the investor is an active trader unless they own the securities in a wrap-around account where they pay a single fee and can trade all they want without loads or commissions.

 

I hope this discussion has cleared up some of the confusion regarding mutual funds and exchange traded funds.  But the question still stands, which is right for you?

 

Generally speaking, exchange traded funds tend to be more appropriate for the self-directed investor who does all of their own research and trading.  Mutual funds tend to be more suitable for the investor who does not trade much and prefers professional management over the do it your self-approach.  However these are very broad guidelines.  I personally have clients who own one or the other and some who own both.  I also have clients who don’t own either.  It really boils down to having a customized financial strategy that is based on the individual’s personal goals and objectives.  This is what will dictate what is right for you.  And this is what I can help you with.  I do not charge for an initial consultation and can be reached at 480-296-9556.

 

Rudy Eidenbock; Purity Wealth Advisors,  4111 E. Valley Auto Dr. #104, Mesa AZ 85206

Office:480-307-9909, Cell 480-296-9556

Purity Wealth Advisors is not a broker/dealer and is independent of Raymond James Financial Services Inc., Member FINRA/SIPC.  Securities offered through Raymond James Financial Services Inc.  Investment advisory services offered through Raymond James Financial Services Advisors, Inc.

All investing involves risk and you may incur a profit or a loss. There is no assurance that any investment strategy will be successful. 

The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Any opinions are those of Rudy Eidenbock and not necessarily those of Raymond James.