Question

What possible advantages does buying an S&P Index ETF have over buying a similar mutual fund? If you could find a similar closed-end fund, what advantages or disadvantages would trading that fund have?

Answer 1

The key advantages of buying an S&P Index Exchange Traded Fund (ETF) over buying a similar mutual fund:-

1. S&P Index ETF funds typically investments are both a combination of stocks listed in NASDAQ/ other U.S. stock exchanges along with bonds, which are typically a part of debt capital markets prevalent in U.S. Therefore, the investors' money in a S&P Index ETF funds would largely be more diversified and hence volatility of returns would be relatively lower than that of mutual funds which typically would invest in bond markets or equity markets or specific asset classes, rather than both bonds and stocks simulatenously.

2. S&P Index ETFs are relatively better tax-friendly to inevstors compared to mutual funds, given that mutual funds typically have high capital gain related payouts annually due to scheduled investor payouts throughout the year, while ETFs would have lesser capital gain payouts due to its higher capability of managing the asset-liability mismatch, which arises from the larger basket of assets it has, and hence better liquidity to manage its redemptions. The S&P Index ETFs are like-kind structures wherein the capital gains tax arising can be deferred by selling one asset and subsequently using the sale purchase consideration to buy another asset of similar nature.

3. S&P Index ETFs are operationally easier to buy as the minimum amount invested could be as less as that of a share's price of that ETF. For mutual funds, there is a minimum investment required. Additionally, the operating expenses of a mutual fund may be well above 1% of the fund's outstanding amount, while for ETFs, the operating assets are typically lower at 0.30%-0.60%.

4. S&P Index ETFs can be dynamically traded throughtout the day while open-ended mutual funds can only be traded at the closing net asset value (NAV) price only once a day.

A similar closed-end fund would typically be simialr to an open-ended fund in most features except that the former has limited number of shares available for investment in the fund versus the latter where the number of shares to be invested can dynamically increase with time. Additionally, a closed-ended fund's price is traded on exchanges on a real-time basis while open-ended fund's NAV is fixed once every day by their NAV. Therefore, the key disadvantages of investing in a similar closed-ended mutual fund over an S&P Index ETF is the points 1 to 3 mentioned above barring point no. 4.