How come ETF's are best?

Jack Ohayon CFA, Aug. 1, 2017, 4:44 p.m.

Everyone knows Mutual Funds is a very popular way to invest in the stock market with limited savings. As the stock markets evolve a better method was created to invest, the Exchange Traded Fund (ETF) which can be considered Mutual Fund 2.0.

The Exchange Traded Fund is uniquely structured because the Fund company and the Investor have no interaction. Authorized Participants (AP’s) play a critical role in keeping the ETF shares trading at or near their net asset value. AP’s are financial institutions (unrelated to the ETF Company) who keep the ETF’s market price close to the ETF’s actual underlying value. APs create and redeem ETF shares also known as “creation units” by trading baskets of the underlying securities with the EFT fund manager.

The total value of all US ETF’s is approximately $3.5 Trillion

The purchase of ETF units is exhibited below 

Features and downsides of ETF’s include:

1. Lower Fees

    - As low as 0.03%

2. Tax Efficient 

    - You have full control over taxes by realizing gain/loss only when it is an advantage to you (unlike Mutual Funds)

3. ETFs can be traded throughout the day like individual stocks (Liquidity)

    - If the market is going higher and you want to capture the profits or is crashing, ETF can be bought / sold right away. Unlike Mutual Funds that can only be bought/sold once a day at 4:00PM after market close

4. No fractional shares 

5. No cash position

    - Like a stock you cannot own ½ a share. Every dollar invested is put to work and not sitting idle as cash. With a Mutual Fund, fractional shares are common but in reality, it sits as cash in the Mutual Fund

6. Transparency of Holdings

    - Know exactly what the fund is investing in

7. Can be shorted

Mutual Funds generally have a straight forward structure as a corporation where you are a shareholder in proportion of the units you own.

The total value of all US Mutual Funds is approximately $16.3 Trillion.

The purchase of Mutual Fund units is exhibited below 

Features and downsides of Mutual Fund include:

1. Higher Fees
    - As high as 3.00%

2. Tax Inefficient
    - When another unitholder decides to sell and realize a capital gain or loss, which is a taxable event, all unitholders are affected will be realizing that transaction even though they had nothing to do with it

3 Liquidity
    - Mutual Funds are only traded once at the end of the day 4:00PM. If market is crashing, you needed to wait until the very end

4. Fractional Shares 

5. Cash Position
    - Even though ½ share of a Mutual Fund unit can be purchased the money is not used to purchase stocks since stocks cannot be purchased in fractional quantities

6. No Transparency of Holdings
    - Mutual funds only report what securities they hold only once or twice a year