Q: Should I get out of my mutual funds and switch to ETFs?
A: I'm often asked questions about Exchange Traded Funds (ETFs). And for good reason — they can be extremely low-cost. This makes ETFs loved by personal finance columnists, and the product structure of choice for robo-advisors. But that doesn't mean you necessarily want to switch from mutual funds to ETFs.
The very first thing you need to do is understand what type of investor you are. Do you want to make your investment decisions all on your own, or do you want to work with an advisor? Do you want to place your own trades and choose your own investment mix, or do you want someone to help you do that? It's important to understand the answers to these questions before you consider making the switch from mutual funds to ETFs.
Benefits of mutual funds over ETFs
1) They're simple to buy and sell. Mutual funds are priced once a day, so if you're buying or selling, you don't have to worry about what the current bid-ask spread is (this is the difference between the buy price and sell price), or whether to choose a market order (a buy or sell order intended to be executed immediately at current market prices) or limit order (an order to buy or sell at a specified price or better).
2) You don't need to rebalance your portfolio yourself. Usually, mutual funds are bought through an advisor or direct fund company, and they can help you rebalance your portfolio. This is really important to understand: it can be very difficult as a self-directed investor to force yourself to sell something that's doing well and buy something that's doing poorly. But that's what buy low/sell high means, and you'll need to be willing to do it if you rebalance your portfolio yourself.
3) You can set up automatic contributions easily. Often for as little as $25/month, you can set up regular contributions that go directly into your mutual fund(s). Automatic savings plans are crucial to building wealth.
Benefits of ETFs over mutual funds
1) You can lower your costs dramatically. ETFs are usually index-based, which means their management fees are low. If your goal is to create the lowest-cost portfolio, then apart from individual securities, which have no ongoing management fees, ETFs are the way to go.
2) You have complete control over your account. For investors who want to create their own portfolios and trade and manage their investments themselves, ETFs offer a world of diversity. You can buy a handful (or less) of broad-market index-based ETFs that have you covered: Canadian equities, U.S. equities, international equities, bonds, and any number of more exotic asset classes.
Final verdict: If you want to be a completely self-directed investor, creating and managing all aspects of your portfolio, you'll probably want to choose ETFs over mutual funds. If, on the other hand, you don't think you're in a position to manage all aspects of your own portfolio, then mutual funds are probably the better option.
Holding ETFs in a mutual fund structure
It's possible to use a mutual fund structure to hold a series of ETFs, and this could be advantageous, since it allows an investor to access a lower cost portfolio that uses ETFs while still having some of the conveniences of a mutual fund structure (namely, the ease of setting up a regular contribution plan to a mutual fund versus placing trades to buy ETFs on an exchange).
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