An Exchange Traded Fund, or ETF is a type of that tracks an index, possibly a commodity such as gold, oil, agriculture, etc., bonds, foreign currencies or a specific style or objective such as inverse of an index. Unlike mutual funds, an ETF trades throughout the day like stocks or equities. Also, they are not managed per se like most mutual funds but again are created most often around an index or index strategy. ETFs often have lower fees than mutual fund shares, because they are based on specific, non-changing, non-managed strategies or indexes making them an attractive alternative for individual investors seeking diversification.
ETF shareholders are receive a proportion of the profits, such as earned interest or dividends as well as the capital gain or loss at the time the ETF is sold.
Advantages of ETFs
ETF investors get the diversification of the index fund they are created and based on. For example, the SPY ETF (SPDR S&P 500) is based on the Standard and Poor’s 500 largest company index. ETF’s also allow the owner the ability to sell short and buy on margin which is not within the guidelines of AmericasRetirmentPlan.com. Another advantage is that the expense ratios for most ETFs are lower than those of the average mutual fund.
When buying and selling ETFs, generally you must to pay the same commission to your broker that you’d pay on any regular order. At AmericasRetirmentPlan.com, we purposely search out no commission ETF’s through our affiliation with TD Ameritrade in order to keep your costs to a minimum.
ETF’s may create favorable tax basis as capital gains from sales inside the fund are not passed through to shareholders as they commonly are with mutual funds.
Due to the Index strategy of ETFs’ this may make them favorable for a Strategic Asset Allocation policy utilized in portfolio selection.
Disadvantages of ETFs
Currently, ETF’s are the favored “pooled” investment stratgey and many websites overlook or don’t even mention their disadvantages. We think that’s wrong!
We really don’t care because we offer both ETF’s and Mutual Funds, unlike many other Robo- solutions. So, with that in mind here’s the skinny on the downside of ETF’s.
As mentioned, ETF’s are based on a basket or group of securities held in an Index. The securities within the ETF are not traded, monitored or managed on any type of ongoing basis. Only as a security such as a stock is eliminated, possibly either through bankruptcy or merger is the security removed or based on a new stock or security that is determined to fit the target parameters of the index, is a security added. This has the potential drawback of underperforming about 15 to 20% of some historically well managed mutual funds.
When indexes in general are going up (as has been the case since April 2009 when the financial crises was at its worst market based trough) most passive investors don’t really mind. However, when market go into a freefall such as September 2008, Indexes and their brethren ETF’s followed suit specifically and exactly in the same channel as did the markets. Most people are not comfortable with that type of volatility and often panic. Some people want “someone” at the helm to guide the ship, especially is bad times as opposed to just going along with whatever.
ETF investors get the diversification of the index fund they are created and based on. While this may present a benefit, it may also present a disadvantage. The fact that an Index like the S&P 500 has the largest companies in the world in the index does not necessarily mean that all of them are performing well. In this index as well as all other indexes you “own” the winners as well as the losers and there is no one there to change that.
With ETF’s, you may be able to buy or own any number of shares, even down to one. The problem this represents is that the price of that one ETF may be too expensive for some clients to get involved with, much less do proper diversification. Also, while there may be a few companies who offer fractional share ownership you limit yourself tremendously to their platform, basically locking yourself into their custodian. At AmericasRetirementPlan.com you are never locked in! If after 90 days with mutual funds and only 30 days with ETF’s, if you want to move from us to another group you have a huge list of available outlets, not just a few.
ETF’s may create favorable tax basis as capital gains from sales inside the fund are not passed through to shareholders as they commonly are with mutual funds. This has the potential to actually lower returns. Again as much as an advantage this is it may also be a disadvantage. Some mutual funds are managed in order to provide net tax favorable results.
AmericasRetirementPlan.com offers both mutual funds and ETF’s. The reason for this is to provide choice but also, based on the onboarding process, we may be able to select the optimum choice, ETF’s or mutual funds for your portfolio based on the answers to the questions answered. When you go through the onboarding process the questions you answer are formulated to come to a conclusion which is most likely the best portfolio to be created for you, ETF’s or mutual funds.
Further, even if you choose for AmericasRetirementPlan.com to do the selection for you, if you would rather have mutual funds managed for you or ETF’s we can design either portfolio for you.
Choice – it’s what America was founded on!