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Why Many Investors Choose ETFs over Mutual Funds

Posted on | March 16, 2017 | No Comments

For many years personal investment brokers were touting the benefits of mutual funds because they were a managed investment vehicle in which you literally owned a small piece of a pie along with other members in the fund and you didn’t really need to know anything about market movement. You could simply look at how that particular fund performed in the last year, or the last number of quarters, and make an investment decision based on that. However, in recent years there is a new kid on the block that appears to be outperforming mutual funds and that would be an ETF, Exchange Traded Fund. If you are asking why, it might be wise to understand the key differences between the two types of funds.

Of Prime Importance – ETFs Are Subject to Much Lower Taxes

When investing in anything whatsoever, from real estate to stocks and bonds, you hope to make a profit. After all, that is the reason you are investing in the first place and this understanding is inherent in the definition of the word ‘investment.’ One of the biggest factors which can affect your bottom line is the amount of taxes you will end up owing to Uncle Sam. Without going into the particulars here, it is widely known in the financial sector that ETFs have a greatly lower tax liability than mutual funds and for this reason, all things considered, ETFs are considered to have the greater potential for profit of the two.

Both Are Managed Funds So Why Choose ETFs?

Especially important to new investors is finding an investment vehicle that is managed for them as they learn the ropes. Both mutual funds and ETFs are managed funds and so there will be an investment manager who oversees the fund in terms of where the group’s money will best be invested so as to yield the highest dividends. ETF Investing is said to have approximately the same performance but will have a higher yield primarily due to lower taxation. However, that is not the only reason why many new investors choose ETF managed funds that are indexed.

Mutual funds are traded only once each day but ETFs, like stocks, can be traded any time the market is open. This means that your funds manager can move investment money around as the market fluctuates, even within the course of a single day. This is also where you should take time to learn about active vs. passive management of your ETF fund because trading styles can affect your bottom line as well.

Which Is Right for You?

While both ETFs and mutual funds are, in simple terms, a group of investors pooling their money to buy into the market, there are differences involving how and when they are traded as well as in the amount of tax liability you will incur. There are other differences as well, but those are the two most prominent differences to understand before looking at which is better for you, personally. For most new investors, the simple fact that ETFs have a much lower (as much as 75%) tax liability all due to long term capital gains inherent in mutual funds is enough to sway their investing decision. Now it’s up to you to learn more about what each is and how they are traded. Only then will you know which is right for you.