ETFs are ‘a huge growth engine in the fund universe’, says expert

It’s tempting to follow the crowd when it comes to investing.

While it may not always be wise, experts say one investment vehicle — exchange-traded funds — might be worth looking at again now.

“It’s been a huge growth driver in the fund space,” said Bryan Armour, director of passive strategies research for North America at Morningstar, an investment research provider.

“This has led to more products, more strategies and more active managers entering the ETF space than ever before,” Armor said.

Year after year, more money was invested in ETFs than in mutual funds. In 2022, the range was the widest, Armor said.

ETFs, which first appeared in the 1990s, are much younger than mutual funds. They also offer some distinct features.

“Our research has shown over the years that cost is one of the best indicators of future success,” Armor said. “And ETFs are much cheaper than mutual funds.”

ETFs are priced and can be traded throughout the day. In contrast, mutual fund orders are typically executed once per day, with all investors receiving the same price.

“It’s a mutual fund that trades like a stock,” Todd Rosenbluth, head of research at VettaFi, said of ETFs.

Rosenbluth, a former stock and mutual fund analyst, today focuses specifically on ETFs, which he says “offer the best of both worlds.”

Certainly, while ETFs offer distinct advantages, they also have disadvantages.

ETFs offer several cost advantages. There is no minimum investment, as long as you can pay for a stock, Armor said. And, in some cases, you may be able to buy fractional shares or part of a share.

ETFs also have lower average expense ratios, which are fees investors pay for running a fund, Armor said. Additionally, there are no distribution fees to compensate brokers who sell fund shares or pay for advertising, and there are no sales charges or commissions for the professional who sells you the fund. funds.

ETFs also don’t need to hold as much cash, keeping your money invested in the strategy you buy, Armor said. In contrast, mutual funds hold cash to pay redemptions, through which investors receive the money they paid for their shares.

“ETFs are generally less expensive,” Rosenbluth said.

It should be noted that ETF investors may have to pay a flat fee to trade.

Mutual funds have annual distributions through which they pass on capital gains and dividends to shareholders.

Mutual fund investors may owe short- or long-term capital gains on these distributions, depending on the length of their investment in the fund.

Since long-term capital gains come with lower rates, they are preferable. However, if an investor has held the fund for a year or less, they will pay higher short-term capital gains rates.

Even though some mutual funds saw a substantial decline in 2022, this prompted investors to redeem their shares, which also generated capital gains, Armor noted.

“As a mutual fund holder, you are subject to the whims of other fund holders,” Armor said. “If they start selling, that could mean a taxable event for you.”

With ETFs, there is no similar taxable event, he noted.

“They are much more tax efficient than a mutual fund,” Armor said.

Of course, ETF investors will not be able to avoid taxes completely. They will have to pay taxes on their own capital gains. But because they have the flexibility to choose this timing, they can wait until they qualify for the lowest long-term rates.

ETFs are a more efficient way to access stocks, bonds or any other asset class in the market, according to Rosenbluth.

“You get the benefits of trading on an exchange; you get the benefits of diversification,” Rosenbluth said. “It’s just an easier way to invest.”

By investing in a fund rather than a single stock, investors can hedge their risks.

“Stock picking can be very difficult, even for professionals,” Armor said.

ETF investors can also choose from a wide range of strategies, whether active or passive, or focused on emerging trends like artificial intelligence, cannabis or clean energy.

Of course, there are limits. Typically, 401(k) plans do not offer ETFs in their investment lineup.

Additionally, investors interested in cryptocurrencies will always benefit from the purest exposure by trading cryptocurrencies directly. But that could be about to change, with spot Bitcoin ETFs in the works provided the SEC approves them.