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Are ETFs better than focused mutual funds
Investing can be tricky for young people to start off with. However, this does not mean that the market should only be reserved for experienced investors with time on their hands. The earlier one starts investing, the likelier they are to gain experience faster and potentially walk away with a great amount of disposable income. Mutual funds are one such way to break into the world of investing. However, they come in different shapes and sizes.
Exchange-traded funds, equity mutual funds, debt funds, hybrid funds, and more, are just a few examples of this variety. Which funds are worth going for and which aren’t? Specifically, when compared to more focused mutual funds, is investing in an ETF a better option? Find out here.
Are ETFs better than focused mutual funds?
The answer: it depends. Here are some of the core differences between mutual funds and ETFs. Compared to the average mutual fund, exchange-traded funds are cheaper. Mutual funds in 2017 had an expense ratio of 0.59% whereas ETFs had a ratio of 0.21%. Exchange-traded funds are also more passive investments than a typical mutual fund. However, there are some passively managed mutual funds too (index funds). Mutual funds aren’t always available through a brokerage but ETFs usually are.
For those young investors who have a difficult time meeting the initial minimum amount required to invest in a mutual fund, ETFs make a lovely alternative. This is typically the case if the young investor uses the buy-and-hold strategy on their ETF, especially when they choose mainstream indices. However, keep in mind that not all exchange-traded funds come with cheaper expense ratios and lower turnover rates. The craze for ETFs has led some inexperienced traders to rely on obscure indices that trade way too infrequently.
Trading using a commission-free ETF can save you money but sometimes it is these ETFs that lack essential index funds. Another potential drawback is that the ETF will do what the index tracking will do. Suppose the index undergoes a major loss, so will the ETF. If the index increases in value, so will the ETF. When mutual funds are actively managed, they can outperform the index, but funds that are passively managed are always at the whims of the overall index they are trialing.
The drawback that mutual funds have is that they are actively managed which typically comes with certain tax implications that young investors are new to. They are also more expensive than exchange-traded funds. If a young investor is familiar with mutual fund taxation and how to manage this, then they don’t have much to lose. Mutual funds are a sound alternative for anybody and can be low cost-friendly as well. If one really wants to save on costs, starting a SIP in a long-term mutual fund investment is the way to go.
Whether one opts for exchange-traded funds or focused mutual funds, the fundamental rules of analysis apply. One should always look at the historical returns of the mutual fund, the company they are managed by, the find manager’s history, the risk to return ratio, and other markers of fundamental analysis.