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Mutual Funds Versus ETFs

black and white chess piece

Exchange Traded Funds Aren’t Always an Investor’s Best Choice

While exchange-traded funds have captured the hearts and minds of investment allocators since the late 90’s, traditional mutual funds- the major competition to exchange-traded funds- are hardly obsolete. In fact, there are many reasons why investors would still opt for mutual funds instead of ETFs.

Some Funds Charge Lower Expenses

Fund managers don’t work for free. They take a portion of the fund’s total value as their payment. However, managers of ETFs also charge a management fee- which eats into the ETF’s value- that can be just as high as the cost of a mutual fund. So, high management fees can be an issue for both kinds of funds…not just mutual funds.

That said, though mutual funds have been criticized for high fees, not all of them are guilty of the crime- plenty of them have done very well at keeping costs low.

Professional Management of Mutual Funds

The idea of picking stocks or ETFs sounds nice, but very few investors actually have the ability to do it consistently well. Of course, not all fund managers outperform the market either. Some can though.

Point being, a manager completely focused on that fund’s success can reap an investor more rewards than he/she may be able gain on their own. Those managers are a minority, but they do exist.

Mutual Funds Offer More Niche Ideas

Though there are now countless ETFs, and many specialized, industry-specific ETFs (such as timber, or coal), there are still many niche investments not yet represented by an exchange-traded fund. International small caps is one example- there’s no ETF built around that segment even though it has historically been a very rewarding group

Some Funds More Liquid Than ETFs

Investors may discover the fluctuation in demand for those small, hyper-focused ETFs is so erratic that it can be difficult at times to buy or sell them at a reasonable price. Traditional mutual funds, however, will always transact a buy or sell order at that day’s closing price (known as the net asset value).

Fewer Positions Are Required With Traditional Funds

An exchange-traded fund by its very nature offers diversity, yet owning just one or two ETFs isn’t adequate protection from volatility or risk. An investor still has the responsibility to select several holdings- ETFs or otherwise- for his or her portfolio. Managing enough trades to maintain meaningful diversity can be challenging to do though, even with exchange-traded funds.

However, traditional mutual funds may hold hundreds of stocks from a variety of style groups, sectors, and market cap groups. So, two or three mutual funds could alone offer an investor enough diversity.

No-Loads Mutual Funds Are Available

Again, most mutual funds have been charged of a crime that only a few funds have committed. It is true that many mutual funds charge a ‘load’, or a hefty up-front commission to initiate an investment in that fund. Not all funds charge this fee though; they’re called no-load funds, and they can be just as profitable as any other fund.

ETFs, on the other hand, always incur a commission when they’re bought as well as when they’re sold. As such, mutual funds may actually be a more cost-effective option, depending on the circumstances.

Mutual Fund Dollar Cost Averaging

Though trivial on the surface, the flexibility to invest in a predetermined dollar amount each week, month, or quarter is quite convenient. This is easily done with a mutual fund, which are bought in dollar amounts rather than by a certain number of shares. And, these automated investments are typically transacted at no cost.

Exchange-traded funds, on the other hand, are only bought in whole numbers of shares, which requires an investor to manually enter each and every trade. Worse, each of those trades will incur commission costs no matter how small they may be.

Mutual Funds Versus ETFs

As these six reasons show, each investor’s personal situation requires careful thought as to which choice makes the most sense for them.

Individuals are best served by defining their goals and strategies first, and then choosing the right solution. If that solution is a portfolio of exchange-traded funds, then so be it. If the proverbial bells and whistles of ETFs are fun but not financially effective, then traditional mutual funds may be the wiser choice.