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What is an Exchange Traded Fund (ETF)

Exchange Traded Funds (ETFs) constitute an accumulation of securities, which are being traded in an exchange. The way ETFs are traded imitates the trade of stocks and their nature is similar to that of index mutual funds. ETFs present many advantages to the investors, but they have some drawbacks as well as it is with every type of investment.

Exchange Traded Fund (ETF) Pros

As it was mentioned above, ETFs are traded almost the same way as stocks are, thus they enjoy a high degree of flexibility. Other advantages of ETFs include:

  1. The trade circulation of ETFs goes throughout the whole trading day. Therefore, intraday trading is provided for the investors, which generally is hardly ever observed with mutual funds.
  2. ETFs enjoy low annual expenses. This characteristic of ETFs turns them into a competitor of even the cheapest mutual funds.
  3. Tax efficient. ETFs provide greater tax efficiency than mutual funds, which is thanks to the SEC regulation. An exception is made when the question comes to non-taxable accounts where they are the same.
  4. Margin buying or shorting is possible with ETFs.

Exchange Traded Fund (ETF) Cons

Even though the advantages that ETFs provide represent a significant reason for investing in ETFs, they have several drawbacks, which are as follows:

  1. Commission Charge. The trading of ETFs is associated with commission fees, which represents an increase in the cost of the transactions made.
  2. ETFs can be purchased and sold above or bellow their net asset value (NAV). This represents an important distinction from mutual funds.
  3. Slippage. This means that there is a difference between the estimated transaction costs and the amount actually paid. For example, if you purchase an ETF for 17 1/9, it is possible to sell it for 17, where the 1/9 represents a hidden charge.
  4. Individual investors have to use the services of brokers. This is due to the fact that only institutions and large investors can access directly the ETF companies.

ETF Analysis

After closely examining both the pros and cons of ETFs, it can be concluded that they are not as good as mutual funds. What puts away most investors from investing in ETFs is the commission fee that should be paid. By putting your money straight in a mutual fund, you can avoid paying commission especially in the case of non-taxable investments like 401 (k) plans or IRAs. Furthermore, the commission charged somehow creates a bad image of the ETFs, presenting them as associate with higher transaction costs.

Additionally, ETFs' disadvantage is further increased in the following cases:

  • Investing a smaller amount.
  • Paying a larger than the stated commission.
  • If reinvestment is implemented.

Some of the advantages of mutual funds over ETFs include:

  1. Small investments.

    Small investments enjoy a higher popularity and financial possibilities with mutual funds, since the returns on the invested small amounts in ETFs will be eaten up by the commission fees you should pay.

  2. Active traders.

    Even though many mutual funds don't recommend active trading, an investor will be better off with an investment in a mutual fund that in ETFs due to the transactions costs and commissions charged.

  3. Non-taxable accounts.

The S&P 500 has proven its efficiency by the higher returns, which are provided over the long term. They exceed the returns made by the actively managed funds, even without taking under consideration of taxes.

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