After taking about 20 years for exchange trade funds (ETFs) to gain popularity, they are “quickly displacing mutual funds as the mainstay of the average investor’s portfolio because of the many benefits they offer,” including lower fees, liquidity and diversification. This according to Validea CEO John Reese in a recent issue of The Globe and Mail.
Like mutual funds, exchange traded funds are baskets of securities designed to follow a particular investment strategy, and much of the money invested in them track an index, such as the S&P 500. Many mutual funds, however, have fund managers that are “actively selecting stocks for the portfolio aiming to beat the benchmark,” writes Reese, “and as readers of this column know, it is very difficult to find active fund managers, in advance, who have long track records of success and don’t charge exorbitant fees.”
The average U.S. equity mutual fund charges a little over one percent per year, writes Reese, while the average fee on an ETF is “about half that, and some much lower.”
The ETF was the brainchild of the Securities and Exchange Commission (SEC) in response to the 1987 stock market crash, says Reese. According to author Eric Balchunas in his book The Institutional ETF Toolbox, it was intended to buffer the equity market from the futures market.
These funds accomplish the same goal as mutual funds, says Reese, but at a lower cost and lower minimum investment thresholds. They trade throughout the day, so price fluctuates with demand and supply—and investors may pay different prices at different times of the day. Mutual funds are bought and sold at the end of the day, when their prices are set.