With the stock market at all-time highs, you’d think the mutual fund industry would be enjoying a boom. Instead, active traders and investors poured a record $300 billion into ETFs in 2017. An ETF, or exchange traded fund, is a marketable security that tracks an index, commodity, bond, or a basket of assets like an index fund and can be traded like a stock. While ETFs have seen consistent growth since their creation in 1993, mutual funds have flattened since then, with growth completely halted since 2000.
(Image courtesy of Bloomberg.com)
Are ETFs the market’s version of a sure thing?
ETFs are a variation of mutual funds, but with some key differences.
And those differences are what makes ETFs so appealing to active traders and investors alike, attracting experienced AND new traders.
In the battle of ETFs versus mutual funds, ETFs come out on top because:
- Lower costs and fees: ETFs typically have significantly lower fees than mutual funds. Mutual funds have a load fee, which ranges from 3 to 8.5 perfect. ETFs skip this cost, though they do carry operational fees and commissions. These commissions are fixed in specific dollar amounts (around $8-$10). Additionally, ETFs don’t carry 12b-1 fees, which are simply advertising, marketing and distribution fees passed onto traders from mutual fund managers. Overall, ETFs have much lower total expenses than other similar investment options such as mutual funds and index funds, making ETFs an appealing option for first time traders.
- Liquidity: One major advantage of ETFs vs mutual funds is that ETFs are so much more liquid. Where mutual funds can only be priced and traded after the close of markets, ETFs can be traded on an intraday basis, giving investors more opportunity to exit a trade if that trade is going against a trader. For this reason alone, ETFs are a fantastic starting point for new investors.
- Popularity: ETFs are growing in popularity, especially amongst millennials and beginning traders. In fact, two different surveys by BlackRock and Charles Schwab, two of the world’s leading investment firms, found that more than 60 percent of millennials identify ETFs as their preferred investment strategy. That’s a major reason in the recent boom of ETFs. And while popularity on its own may not justify an investment, when paired with the various other perks of ETFs, rising popularity ensures that ETFs will be sticking around and rising for some time to come.
- Instant diversification: Originally, the first ETFs simply tracked equity indexes the first like the S&P 500 and the Dow. Now, ETFs cover just about all asset classes including stocks, bonds, real estate, commodities, currencies and international investments. Plus, there are various other ETF options such as inverse ETFs which trade opposite a market and leveraged ETFs, which multiply an ETF’s results. The various ETF options available to investors means that a new trader has a wide range of choices when it comes to starting off with ETFs.
- Tax advantages: Due to structural differences, mutual funds see more capital gains taxes than ETFs. ETFs only incur a tax when they’re sold off. With mutual funds, the tax is passed on throughout the life of the investment. For new traders, this means more simplified reporting and lower expenses.
- Passive: Passive investing simply focused on trading one (or more) market index rather than managing multiple stocks, which takes a more active approach. This is great for new traders because it affords you the opportunity to familiarize yourself with the market before trying new, more complex strategies such as technical analysis, which can be more rewarding. Traders can also benefit from ETF’s for longer term positions for funds they don’t want to actively trade.
- Leverage: ETFs have a unique ability called leverage. A leveraged ETF is a fund that uses financial derivatives and debt to amplify the returns of an underlying index. Basically, you’re borrowing in addition to your investment. Hypothetically, if you’re investing $100 into a 3x leveraged ETF, you’re then responsible for $300. While carrying risk, this can really come in handy when taking advantage of an index’s short-term momentum. There are more than 200 leveraged ETFs available, meaning new traders have plenty of choices here.
A “sure thing” doesn’t exist in the markets. That’s why smart trading and having a strategy is so important for investors. ETFs are rising in popularity among not only millennials but also new and experienced traders. If you’re just starting off, ETFs provide a smart, safer trading choice while allowing you to develop a more advanced trading strategy, especially given how easy they are to trade and the low costs associated with them. But keep in mind, even though ETFs are an increasingly popular choice among traders, there is still risk involved. Just like stocks, options, or futures, make sure you have a plan in place before diving in and trading.