Mutual funds are currently the most popular investment vehicle for the majority of investors but there are many disadvantages that investors should be aware of. Disadvantages include high fees, tax inefficiency, the potential for style drift and excessive trading costs. There are two major types of mutual funds. The first is sales charge load funds that are designed to be sold by stock brokers who earn their living from commissions rather than from fees. According to Zack’s Investment Research, the average sales load range is between 4% and 5% on all money deposited into these funds. They also often have annual 12b-1 fees which are an additional source of compensation for commission-based brokers. A no-sales charge load fund normally will have no 12b-1 fees and also will be sold without load charges. In addition to these charges all mutual funds have annual expense ratios which often are in excess of 1% per annum.
The tax inefficiency of mutual funds is also important for investors to know. As a mutual fund manager makes buying and selling decisions throughout the calendar year, any capital gains and dividend income received will be taxable to the shareholder unless they are held in an IRA or some form of a retirement account that is tax deferred. In addition, mutual funds can never be sold in the middle of a trading day or at the market open. They must be sold at the end of the trading day. For instance, if you decide you want to take your money out of the market during a period of extreme volatility, you may be locking in large losses as you will be receiving the sale proceeds based on the closing price of the assets in the fund that day.
In addition, the vast majority mutual funds do not outperform the S&P 500 stock index which is widely used as a measure of how well or how poorly the fund performs. Many investors may consider investing in a no-load mutual fund that tracks the S&P 500 stock index. The disadvantage to investing in the S&P 500 stock index is that it is made up of 24 different industry groups, many of which will suffer in an economic downturn or periods of high interest rates.
Exchange traded funds were created in 1993. They represent a much more modern version of investing versus mutual funds. There are no exchange traded funds that charge sales loads, so in that respect they look like a no-load mutual fund. Exchange traded funds (or, as they are known in the industry, ETFs) are more transparent than mutual funds. They report their holdings daily so you can clearly see what’s in the exchange traded fund that you own. With an ETF, you buy shares just as you would any stock and you can buy or sell an ETF anytime during the trading day or at the market open.
ETFs also tend to be much more tax-efficient than mutual funds because of their unique structure. ETFs typically can defer capital gains distributions by shedding their lowest basis shares to institutional traders. Historically they have lower operating costs than mutual funds and they do not have 12b-1 fees that are deducted from mutual fund assets.
There are a wide variety of exchange-traded funds many of which focus on specific industries or market indexes. You can buy domestic or international ETFs, fixed-income investments both domestic and international, as well as commodities including gold, silver and various forms of precious metals.
Exchange traded funds are growing increasingly more popular every year. This investment vehicle was created to combine the characteristics of both stocks and mutual funds into a combined investment structure while leaving out some of the less desirable features.
If you would like to learn more about how exchange traded funds may reduce your cost of investing and potentially increase your rate of return please reach out to our office. We can arrange a Zoom visit where we can learn more about you, your specific situation and how much risk you’re comfortable taking. Our toll free number is 1-800-303-9255.
Disclosures :
- This newsletter may include forward-looking statements. All statements other than statements of historical fact are forward-looking statements (including words such as “believe,” “estimate,” “anticipate,” “may,” “will,” “should,” and “expect”). Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to be correct. Various factors could cause actual results or performance to differ materially from those discussed in such forward-looking statements.
- Past performance is not indicative of any specific investment or future results. Views regarding the economy, securities markets or other specialized areas, like all predictors of future events, cannot be guaranteed to be accurate and may result in economic loss to the investor.
- This newsletter is intended to provide general information only and should not be construed as an offer of specifically tailored individualized advice.