The Theory and Practice of Investment Management: Asset Allocation, Valuation, Portfolio Construction, and Strategies, Second Edition

MUTUAL FUNDS VS. ETFs: RELATIVE ADVANTAGES

As mentioned earlier, MFs are priced only once a day by being redeemed or offered by the mutual fund company at a price equal to the NAV. On the other hand, ETFs are traded on an exchange and so are priced continuously throughout the day. For MFs, the price of the fund is exactly the NAV of the underlying portfolio. For ETFs, there may be a discrepancy, although for actively traded funds, the discrepancy is very small. ETFs, since they are traded on an exchange, can also be shorted, leveraged and limit and stop orders can be used. This is not the case for MFs.

Both passive MFs and ETFs have low fees, but ETF fees tend to be somewhat lower. All ETFs trade on an exchange and, thus, incur a commission, ranging from a discount to a full-service commission depending on the broker used. MFs may be either no-load funds or load funds. For frequent, small investments—for example, monthly payroll deductions—MFs would most likely be better since no-load MFs cost nothing to trade and ETFs incur a commission cost. This is the reason that ETFs have not been widely used in employee retirement plans, such as 401(k) plans. For infrequent, large investments, ETFs may be better because of their somewhat lower expenses.

With respect to taxes, MFs, as discussed above, may lead to capital gains taxes for investors who do not even liquidate their fund. This is because the fund has to sell securities in their portfolio to fund the sales of shares of other ...