Dear Mr. Market:
The stock market is made up of thousands of choices and one easy way to gain exposure to it is via mutual funds. While we don’t want to broad brush the topic, we’re going to get right into it and explain 100 reasons why you or your financial advisor should not be using mutual funds versus ETFs (Exchange Traded Funds).
Costs/Expenses: ETFs typically have lower expense ratios compared to mutual funds. This is because ETFs are passively managed and aim to replicate the performance of an underlying index, reducing the need for active management and associated costs.
Tax Efficiencies: ETFs are generally more tax-efficient than mutual funds. The “in-kind” creation and redemption process used by ETFs can help minimize capital gains distributions, as it allows for the transfer of securities between the fund and authorized participants without triggering capital gains taxes. There’s nothing worse than getting a tax bill from a mutual fund that has lost money for you. (Yes…it happens all the time!)
Diversification: ETFs offer investors the ability to diversify their portfolios by gaining exposure to a broad range of assets, sectors, or regions. This is similar to mutual funds, but ETFs often have lower minimum investment requirements, making it easier for investors to achieve diversification with smaller amounts of capital.
Liquidity: ETFs generally have higher liquidity than many mutual funds, as they trade on stock exchanges. This can be particularly important for investors who want to enter or exit positions quickly without affecting the market price.
Trading Flexibility: ETFs trade on stock exchanges like individual stocks, allowing investors to buy and sell them throughout the trading day at market prices. Mutual funds, on the other hand, are bought or sold at the end of the trading day at the net asset value (NAV). This gives investors greater flexibility and control over their trades with ETFs.
Intraday Trading: ETFs can be traded throughout the day at market prices, allowing investors to take advantage of intraday price movements and execute trades at specific price levels. Mutual funds can only be bought or sold at the end of the trading day at the NAV.
Flexibility in Trading Strategies: Investors can use various trading strategies with ETFs, such as limit orders, stop orders, and short selling. Mutual funds typically do not offer the same level of flexibility in trading options.
Transparency: ETFs provide real-time pricing information because they trade on stock exchanges. Investors can see the current market price of an ETF and make informed decisions based on up-to-the-minute data. Mutual funds, on the other hand, provide NAV (Net Asset Value) once a day after the market closes
Performance: The other 92 reasons can be summed in the following graphic.
The numbers don’t lie. Every once in a while a mutual fund will outperform their respective index and benchmark. Over time, however, those odds become increasingly small and overwhelmingly in favor of ETFs. The above illustration shows that after 15 years over 92% of mutual funds underperformed the unmanaged index. (If you’d like to know the numbers on shorter time frames or for different asset classes like Small/Mid Cap, Bonds, International etc, please let us know).
While not all mutual funds are horrible, the facts above are a major reason why we, at My Portfolio Guide, LLC, will hardly ever use a mutual fund. Ironically enough the Dave Ramsey’s of the world are doing some novice investors a service by getting them out of debt and started towards investing, but a huge disservice by not educating or going a simple step further in explaining why mutual funds are inferior to ETFs. Lastly, it’s not 1985 anymore so any financial advisor pitching you a mutual fund is either not educated or they are on commission and gaining something from the outfit they’re connected to.