Exchange-traded funds offer flexibility, efficiency
If you regularly search for the Land of Oz in investing you may have noticed that something new and different has come to the investment vehicle neighborhood. They’re called exchange-traded funds, or ETFs. With exciting names, and even more exciting benefits, these funds are changing the way many brokers and financial advisers diversify their client’s portfolios.
They have been around for a decade, but with lower fees and the additional bonus of intra-day trading, their flexibility is turning heads and wallets in the direction of these index tracking wizards.
ETFs are a highly effective way for investors to participate in the financial markets for the following reasons:
• Flexibility: Though they have the structure and benefits of mutual funds, ETFs act like stocks, minimizing many of the unfavorable elements of the traditional mutual fund approach. There are several features that you as an investor receive with this style. The immense flexibility allows investors to employ all of the strategies associated with stocks, such as market orders, limit orders, stop orders, short sales and margin buying. There also is the ability to day-trade ETFs. No more waiting for the 4 o’clock closing bell to get a price, as with mutual funds. Since an ETF allows for pricing throughout the day, the investor gets the best possible price.
Another benefit: Have you ever bought a mutual fund directly from the fund company? Lots of signatures and forms. When you buy an ETF, you do it just like a stock — one call and you’re done.
• Tax efficiency: Traditional mutual funds operate through specific sales events that incur tax consequences. ETFs maneuver through non-taxable trades for the value of the underlying stocks. ETFs have a unique product structure that allows them to substantially mitigate or possibly avoid capital gains distributions. Because ETFs trade on an exchange just like stocks, ETF shareholders have more control over their tax situation because they are not impacted by the purchases and redemptions of other shareholders.
• Low costs: ETFs do not have to pay the expenses that traditional mutual funds have, therefore their fees are lower.
• Diversification: ETFs are invested in a variety of available indexes, from the S&P 500 to the Dow Jones Industrial Average. Because you are investing in the indexes, diversification is automatically available. In an ETF you are not putting your eggs in one basket, you are putting them in many baskets, creating an element of safety
• Performance: The majority of actively managed mutual funds do not outperform their benchmarked index. Index funds offer the investor the ability to keep up with the market indexes. Part of this performance is due to the lower fees. Also, commissions paid on security transactions are very low because of the large size of the funds. In addition, almost no uninvested cash is maintained by the funds, and there is very little asset turnover in index funds.
Because ETFs are sold like a stock, you need to purchase them through a Series 7 licensed broker. A number of brokers have a Series 6 license, which allows them to sell mutual funds and annuities, not exchange traded funds and stocks. A number of investment companies also do not allow their brokers to give advice on ETFs and stocks, which explains why some financial consultants are not recommending ETFs to their clients.
ETFs are becoming more and more popular because of their flexibility, tax efficiency and attractive fee structure. If they sound like something you’d like to dive in to, consult your financial consultant today.
Margaret Tully is chief investment strategist at Tully & Co. Investments LLC, Chester. She can be contacted at mtully@tully-investments.com.
