When looking to invest, it’s easy to become overwhelmed by your investment options. There is a lot of information filling the airwaves about the various ways you can invest and why you should use them, but what is the best investment tool for you? Many people try to simplify their investments by utilizing Exchange Traded Funds (ETFs) or Mutual Funds which allow investors to hold diversified portfolios for a low cost. Even narrowing down to these two options, though, we as investors still have to ask the question, “Which one is right for me?”
At Wela, we utilize ETFs for our clients to help them save money with their investments while also keeping their portfolios properly diversified. Think of an ETF as a grocery basket. You can put a lot of different items into that basket. When you go to the store, you use a basket to carry the variety of things that you need to purchase in a more efficient manner. If you didn’t have that grocery basket, you’d only be able to buy a couple of things because you couldn’t carry 20 different products (milk, eggs, lettuce, case of beer, etc.) in your arms. Instead, you’d need to make multiple trips which would be less efficient. So think of an ETF as your grocery basket, but instead of groceries it holds different investments. Some ETFs hold stocks and others hold bonds. Others ETFs hold commodities like gold or silver.
ETFs are actually not the first investment option to operate like this, though. Mutual funds are designed to do the same thing. The difference in a mutual fund, though, is the process and costs associated with putting your “grocery basket” together.
When deciding between these two investment vehicles, consider the following differences:
- Cost of the basket – According to Morningstar, the average ETF expense ratio, the cost to hold the investment (what you are paying each year for the investment) was 0.6% compared to 0.73% for index mutual funds and 1.45% for actively managed mutual funds. But this doesn’t tell the whole story. Mutual funds carry other fees that you don’t necessarily see… whether it is the cost to buy and sell the mutual funds or commissions that mutual funds pay the broker that sold you the mutual fund.
- Tax implications - Mutual funds incur taxable gains when the different securities are bought and sold. These taxes are passed on to the investors. Inside an ETF, no taxable event occurs.
- Trading one basket for another – In a mutual fund, if you wanted to buy or sell shares, then you’d be doing so directly from the company who makes the mutual fund. Since this is the case, the mutual fund is only priced once each day. So at noon, for instance, you have no idea what your mutual fund is worth, and if you were to sell it you wouldn’t know how much you got for it until the very end of the day, after the market has closed. In an ETF, the pricing is done real time and is very similar to a stock. If you wanted to buy (or sell) an ETF at noon, you’d know the price of that ETF when you traded it.
Now, it may sound like we’re dogging mutual funds here, but we’re certainly not. There are benefits to buying mutual funds, but oftentimes those benefits are sought out in a more specialized situation. ETFs are sometimes described as 21st-century mutual funds. The reason for this is because they are essentially doing what mutual funds are intended to do but in a more efficient manner. Thus, we prefer to use ETFs over mutual funds at Wela.
If you’re interested in learning more about Wela’s investment strategy, visit our Investment Models page and sign up for a free account. Work with the team at Wela to determine which investment solution is best for your financial situation.
Disclosure: This information is provided to you as a resource for informational purposes only. It is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal. This information is not intended to, and should not, form a primary basis for any investment decision that you may make. Always consult your own legal, tax or investment advisor before making any investment/tax/estate/financial planning considerations or decisions.