Learn more about ETF investing, including its benefits and how it differs from other investment funds.
In this article:
- What Is an ETF?
- Four ETF Benefits and How ETF Investing Relate to Other Investment Funds
- Investors Who Would Be Probably be a Good Fit for ETFs
ETF Investing | Is It Any Good for Money Growth?
What Is an ETF?
An ETF is a mix between a mutual fund and a stock. A better description—it’s similar to a mutual fund and traded like a stock.
- Similar to mutual funds, ETFs can hold assets.
- Just like stocks, they’re traded daily.
It used to be that mutual funds were the must-have for investors looking for ways to expand the profitability of their IRA. The introduction of the first exchange-traded funds (ETFs) in 1993 started the push toward making ETFs the go-to fund for IRA owners, particularly younger ones.
Fund Performance and Composition of an ETF
An ETF can be based on an underlying index, market, or investment vehicle. Here are some examples:
- Stock-Market Index — The investment will be based on the S&P 500 Index
- Industry — Investing in stocks and securities in the Energy sector
- Investment Vehicle — Commodities investing, such as investing in precious metals like silver and gold
You can find an available ETF for virtually any individual market exchange, commodity, or equity sector.
Four ETF Benefits and How ETF Investing Relate to Other Investment Funds
There are several benefits to investing in ETFs over other investment funds.
1. Access to Real-Time Trading and Liquidation
When it comes to the “ETF vs Mutual Fund” battle in real-time trading and liquidation, ETFs edge out mutual funds.
Compared to mutual funds, where closing prices are only finalized at the end of the trading day, ETFs trade in real-time. Since the price of ETFs varies throughout the day, investors can take advantage of market highs and can also save more. Investors can gain more control over the entire trading process and the rates at which they trade.
- A mutual fund investor decides to purchase shares in the morning, then prices suddenly increase towards the end of the day. The investor will have to pay this higher amount, and not the previously cheaper price during the earlier part of the day.
- In contrast, an ETF investor will get the prices the moment they ordered. This helps them plan out a strategy and get a better idea of how much their transactions will cost.
2. Tax Efficient
Actively managed mutual funds are handled by teams of experts looking for investment products to trade to increase their value.
Here, fund managers decide what and when to sell and buy to beat the market, which often results in a high turnover. This results in capital gain distributions reported on 1099 forms from fund companies during tax season.
As a passively managed fund, ETFs offer a “hands-off” approach since they are just meant to match the current market by mirroring it and tracking indices, not outperform it.
Since ETFs follow an index, there is a lower turnover. Investors will have lower odds of incurring capital gains taxes on fund distributions.
Investing an ETF in a Roth IRA Can Also Provide Tax Savings
A Roth IRA ETF can also provide tax savings since it provides investors with tax-free growth on retirement investments. A good Roth ETF investment can go a long way in helping improve one’s retirement.
What is Capital Gain? It is the profit one gains from selling an asset, such as real estate or investment.
3. Lower Management Fees, Fund Expenses, and Buy In
Management Fees and Fund Expenses
Actively managed funds require more activity from the fund manager, which costs more than passive management.
Mutual funds also incur 12(b)-1 fees, which are annual marketing and distribution fees taken out of the fund. This may seem small but add up over time.
Mutual funds may also sometimes require the payment of redemption fees upon liquidation of its position. They can be substantial by up to several percentage points.
There are no 12(b)-1 fees and redemption fees on ETFs. This can then increase an investor’s potential rate of return over the long haul with ETF investing.
Unlike mutual funds, ETFs don’t have a minimum purchase because it allows investors to purchase fractional shares. This is what makes it attractive to younger investors who don’t necessarily have a lot to spare right off the bat.
4. Diversification Opportunity
One cannot overstate the importance of a diversified portfolio. ETFs offer an excellent way for investors to create one, thanks to the variety of ETFs available.
- Asset Allocation — Investors can use ETFs to build portfolios that meet their specific asset allocation requirements. They can choose from those covering major indexes, international markets, and niches within a variety of industries.
- Asset Classes — Another advantage of ETFs is it covers other asset classes, like fixed income. Their investors can look through options like short-, mid-, and long-term bonds. Investors can also reinvest or deposit the dividend payments from ETFs into brokerage accounts.
Investors Who Would Be Probably be a Good Fit for ETFs
These benefits attract certain types of investors to an ETF. Here are some examples:
- ETFs can be suitable for those who feel their mutual funds don’t perform to their expectations and are no longer worth the fees and costs.
- They can also be a good choice for individuals looking for more control over their annual tax liability.
- Others who may be interested in ETFs include long-term investors who like to position themselves for years with specific funds.
When it comes to investing, it’s ideal to factor in different things, such as investment goals, time frame, tolerance to complexities, and budget, before making any decisions. Based on these factors, certain investment funds, such as exchange-traded funds, can offer benefits that will be particularly helpful to an investor. Each investment is unique and has to be crafted individually to suit an investor’s needs and preferences.
What got you interested in learning more about ETF investing? Share your experiences and thoughts in the comments section below.