Question

Explain the advantages of purchasing an exchange traded fund over common stock and the difference between a mutual fund and an exchange traded fund.

Answer 1

The advantages of purchasing an exchange traded funds over a common stock are as follows:-

1.Tax friendly investing - unlike mutual funds ,exchange traded funds are very tax efficient.Mutual funds typically have capital gain payouts at year end,due to redemption throughout the year ;exchange traded funds minimize capital gains by doing like-kind exchanges of stock,thus shielding the fund from any need to sell stocks to meet redemptions.Therefore,it is not treated as a taxable event.

2.No investment minimums - Several mutual funds have minimum investment requirements of $10,000,$5,000 or even $4,000.Exchange traded funds on the other hand,can be purchased for as little as one share.

3.Lower cost alternatives - The average mutual fund still has an internal cost well over 1%,whereas most exchange traded funds will have an internal expense ratio typically between 0.30-0.95%.Plus,Exchange traded funds do not charge 12b-1 fees(advertising fees)or sales charges,as do many mutual funds.

4.More trading control - Mutual funds are traded once per year at the closing NAV price.Exchange traded funds trade on an exchange all throughout the trading day, just like a stock.This allows you greater purchasing/selling price control and the ability to set protection features,such as stop loss limits on your investments.

The difference between mutual funds and exchange traded funds are as follows -

1.Mutal funds have comparatively higher cost effectiveness since they are actively managed with high trading activity and volume of transactions,requiring larger operating fees and commissions whereas exchange traded funds have comparatively lower cost effectiveness since and they are usually passively managed funds.

2.Mutual funds offer comparatively more tax localities whereas Exchange traded funds offer gains tax benefits due to the manner of their creation and redemption.

3.Most mutual funds have a minimum investment limit specified in their terms .This amount is higher than the net asset value of one unit of the fund whereas ETFs are not constrained by any minimum investment.You can be are ETF investor by buying just one unit of the fund.

4.Mutual funds have comparatively lower liquidity whereas ETFs have higher liquidity is connected to the liquidity of stocks included in the index.

5.In mutual funds investors do not need to open a brokerage account to invest in a mutual fund whereas in ETFs a brokerage account is necessary to trade ETF units in the stock exchange.