Do ETFs Belong in Your Portfolio?
Published: June 02, 2020
Investor demand for exchange-traded funds (ETFs) has increased over the last decade due to some attractive features that set them apart from mutual funds. At the end of 2019, almost $4.4 trillion in assets was invested among 2,096 ETFs. This is equivalent to more than 20% of the assets invested in mutual funds. In 2009, ETF assets were equivalent to only about 7% of mutual fund assets.1
Fund Meets Stock
Like a mutual fund, an ETF is a portfolio of securities assembled by an investment company. Mutual funds are typically purchased from and sold back to the investment company and priced at the end of the trading day, with the price determined by the net asset value (NAV) of the underlying securities. By contrast, ETFs can be traded throughout the day on stock exchanges, like individual stocks, and the price may be higher or lower than the NAV because of supply and demand.
In relatively calm markets, ETF prices and NAVs are generally close. However, when financial markets become more volatile, ETF prices may quickly reflect changes in market sentiment, while NAVs — adjusted once a day — may take longer to react, resulting in ETFs trading at a premium or a discount.
Most ETFs are passively managed and track an index of securities. Investors can choose from a variety of indexes, ranging from broad-based stock or bond indexes to very specific market sectors. A growing number of actively managed ETFs assemble a non-indexed mix of investments chosen to meet the fund’s objectives.
Trading, Expenses, and Risks
ETFs typically have lower expense ratios than mutual funds, which is a large part of their appeal. However, you generally must pay a brokerage commission when you buy or sell shares, so your overall costs may be higher, especially if you trade frequently. Also, whereas mutual fund assets can usually be exchanged within a fund family at the end of the trading day at no cost, moving assets between ETFs requires selling and buying assets separately, which may be subject to brokerage fees and market shifts between transactions.
Mutual funds typically have minimum investment amounts, but you can generally invest any dollar amount after the initial purchase, buying partial shares as necessary. By contrast, you can purchase a single share of an ETF if you wish, but typically you can only purchase whole shares.
The trading flexibility of ETFs may add to their appeal, but it could lead some investors to trade more frequently than might be appropriate for their situations. The principal value of ETFs and mutual funds fluctuates with market conditions. Shares, when sold, may be worth more or less than their original cost.
Exchange-traded funds and mutual funds are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.