On the front page of Digg.com a week or so ago, was a story about Google before they had their IPO. The story was about how they wanted to protect their employees from stock brokers and money managers who would try to separate all the new Google millionaires from their money. Google’s senior VP Jonathan Rosenberg, brought in some of the most revered names in investment theory to teach them about the fine art of personal investing. Stanford University’s William (Bill) Sharpe, Burton Malkiel and John Bogle. All three had basically the same advice… don’t try to beat the market. Put your savings into some indexed mutual funds, which will make you just as much money (if not more) at much less cost by following the market’s natural ebb and flow.
After reading this, as well as several other articles regarding passive investing, index funds and exchange traded funds (ETFs), I thought I would write about some of the benefits of investing in ETFs.
- Cheap Diversification: When you first start investing, diversification can be cost prohibitive if you’re using traditional mutual funds, which frequently have a minimum investment of $2500 or more. Because ETFs have no minimum investment, they are a good vehicle for diversified investing. Diversified investing = lower risk.
- Tax Efficiency: Upon redemption, mutual funds must sell its underlying securities, and the capital gains are then distributed to the owners of the funds. Since ETFs trade on an exchange and investors are selling to other investors, no underlying securities are sold, and no capital gains are distributed. If the makeup of the ETF changes it will, occasionally have to distribute gains, but it should be less frequent than with traditional mutual funds.
- Lower Fees: Low cost is a key to ETFs’ appeal. Because ETFs are passively managed - they all track indexes of one sort or another - annual management fees are minimal. According to Money.com, the average ETF has a 0.41 percent expense ratio, vs. 1.35 percent for an actively managed mutual fund and 0.74 percent for an index mutual fund. ETFs are no-load funds, and you won’t be slapped with a redemption fee when it’s time to liquidate your position.
- Liquidity: The exchange-traded structure of ETFs generally allow for liquidation of a position faster than a mutual fund, which must be liquidated at end of day. Further, the ability to set a limit order allows flexible trading that no investor could get from a mutual fund.
- Intraday Pricing: Because ETFs are traded on active stock exchanges, purchases and sales happen at market prices, rather than end-of-day Net Asset Value, which mutual funds use. As a result, one may purchase ETFs at a premium or a discount to the value of the underlying assets.
As always, before investing, make sure to do your homework. You can do a good amount of research on ETFs on Money.com, and Yahoo Finance.