Advantages of Exchange Traded Funds over Mutual funds

Article Written by : Scrumpy Jack

The Exchange Traded Fund (ETF) industry is a $1.5 trillion strong and expanding exponentially. At the same time the luster of mutual fund industry is taking a back seat. Why ETFs are so hot? There are several reasons.

Lower cost: ETFs are less costly to buy compared to mutual funds. Mutual fund fees include transaction fees, distribution charges, transfer-agent cost and they pass along annual capital gains to the holder. Some mutual funds also charge a sales load known as 12b-1 fees based on the 1940 Investment Company Act. In contrast, ETFs do not carry a load fee. They are traded on exchanges paying broker fees or sales commission same as for trading stocks. No 12b-1 fees. According to Morningstar, the average ETF fee in 2010 is 0.6% compared to 0.73% for index mutual funds and 1.45% for actively managed mutual funds.

Liquidity or ease of trading: ETF offer greater flexibility when it comes to trading. ETF shares are traded throughout the day like stocks while mutual fund NAV is calculated at the end of the day.

Tax efficiency: ETF offer tax advantages to the holder. Mutual fund capital gains are distributed to all holders before the end of the year and ETFs offer “in-kind redemptions” to holders limiting any capital gains.