Putting the “Trade” in Exchange-Traded Funds
As should be clear by now, the big innovation of ETFs over mutual funds is that you can trade them like stocks. You can do a stop-loss order or a limit order, and you can sell them short.
Why is trading so important? ETFs give investors the ability to trade a “single stock without the single-stock risk.”1
Trading allows you to make the trade when it’s most advantageous to you. Trading offers continuous pricing and liquidity, which is the ability to buy or sell very quickly. If you need money fast, the ability to price and time your purchase or sale can mean the difference in millions of dollars.
Prior to ETFs, investors used futures for index funds to catch the market’s move. Many investors like ETFs better than index futures because they offer four distinct advantages: smaller order sizes, no special accounts, no roll costs, and futures have tighter margin requirements.
Investors who couldn’t fund futures accounts, or just didn’t want to trade futures, were left with trading shares of index funds. As mentioned before, this harms both the trader of the fund shares and the fund’s long-term investors. The trader can only buy or sell at the end of the day, with little control over the price he pays. Meanwhile, the long-term investor suffers because on every sale the fund must pay a broker commission and potentially incur capital gains taxes. Therefore, mutual fund investors also benefit from ETFs because they remove cost-producing ...