By: Julio Perez, Spring 2018 IAC Graduate Research Assistant
A good follow-up to discussing mutual funds is a discussion on the very similar yet distinct exchange-traded funds, or ETFs. Just like mutual funds, ETFs are groups of stocks, bonds and other assets which can be invested en masse by a group of investors and managed by a professional portfolio manager. Like mutual funds, ETFs are also regulated by the SEC.
An ETF can either be index-based, which means it tracks the performance of a specific benchmark or index (such as S&P 500 or NASDAQ 100 index), or they can be actively managed by a manager who can choose a mix of investments to pursue a particular investment strategy.
There are some key differences between ETFs and Mutual Funds, including:
- The operating expense ratios for ETFs tend to be lower than those for mutual funds.
- While mutual funds require quarterly disclosure of their public holdings, many ETFs tend to require daily disclosures.
- ETFs tend to be more tax efficient than mutual funds since they are generally redeemable “in kind.” Although the reason why is fairly convoluted, ETF transfers tend to avoid creating taxable gains by delivering specified securities to the aforementioned Authorized Participants who “redeem” the securities instead of selling them. This taxable difference is fairly nuanced and can elude a less sophisticated investor, which is why one should consult their tax adviser if seeking to invest in ETFs for tax reasons.
Translated: “I would rather invest in ETFs because I believe I understand them enough to turn out a better profit than with mutual funds.”