RIP Mutual Funds, ETFs are here to Stay

The landscape of the investment industry has drastically changed in the past decade. If I asked you ten years back if you knew about Exchange Traded Funds (ETFs) you would have likely paused and questioned the meaning of the three letter acronym they are most commonly known by.

Although the first ETFs were developed in 1989, it was not until this past decade that the growth of assets invested in these instruments has soared.   A recent study by Ernst & Young reports that over the next 5 years assets invested in ETFs are expected to grow by 15-30% annually.

Currently the average investor is much more familiar with Mutual Funds, which have been around since the 1920’s, than they are with other investment alternatives. With ETFs offering similar advantages to Mutual Funds, in addition to significant cost savings, maybe it’s time to consider ETFs when investing your hard earned savings?

Let’s take a look at a few differences.

Trading: An ETF trades like a stock; it can be bought and sold whenever the market is open. In contrast, mutual funds can only be bought or sold at the end of a trading day and do not offer much trading flexibility.

Taxation: You may remember receiving capital gains distributions from your mutual fund holdings. Whenever a mutual fund realizes a capital gain that is not balanced by a realized capital loss, these gains are re-distributed to fund holders. The selling of assets within a mutual fund portfolio can occur due to fund redemptions or even a rebalancing of assets. These capital gains are taxable to all shareholders, even those who chose to stay invested. On the other hand, most ETF’s will only realize capital gains or losses when the shareholder decides to sell the fund. For this reason exchange traded funds are typically more tax efficient than conventional mutual funds.

Cost: Why should you pay more for your investments? Proponents of ETFs are the first to point out the cost benefits of ETF investing. The annual fee assessed on ETFs, known as the Management Expense Ratio (MER), can range from as low as 0.05% to 0.75%. In comparison, mutual funds have much higher MERs, and range from 0.5% to 3.5%.

Returns vs. Benchmark: In SPIVA's Scorecard for 2013, it was found that in three critical asset categories; Canadian, U.S. and international equities, close to 90% of the actively managed funds failed to beat their comparative indexes for the period of 2008 to 2012. If around 90% of portfolio managers can’t beat the market, why should you pay a premium management fee to hold their funds?

Admittedly exchange traded funds are not for everyone and building a proper diversified portfolio can often be a more daunting task than investing your funds in a pre-formatted asset weighted mutual fund alternative. However, with the help of a skilled financial professional, any mutual fund portfolio can be replicated with ETFs and will offer you increased flexibility and large cost savings over time.

Take a look at your portfolio. It may now be time to bury those mutual funds and explore a new alternative!