Exchange traded funds (ETFs) are gaining in popularity, but are they right for you?
ETFs are similar to index funds, but they trade like a stock, meaning they can be bought and sold throughout the day instead of just once a day.
Advantages:
Low cost – ETFs have a lower annual expense than most mutual funds, including most index funds. According to Morningstar, the average expense ratio for ETFs is 0.30%, compared to 0.35% for no-load index funds, and 0.96% for all mutual funds.
Tax efficient – ETFs don’t have to sell stock positions to meet shareholder redemptions, which cuts down on taxable transactions. Also, redemptions by large shareholders are paid in kind, protecting investors from unnecessary taxable events.
Disadvantages:
The main disadvantage of ETFs is that they can only be bought through a broker, which means you will pay transaction costs each time you purchase an ETF.
Conclusion: ETFs can be a great way to diversify your portfolio, especially if you are making a one-time purchase. But if you make regular purchases, such as with dollar cost averaging, the transaction costs can end up costing you more than if you had purchased an index mutual fund.
To learn more about ETFs, check out the Exchange Traded Funds Center at Morningstar. In addition, you can read more about iShare ETFs managed by Barclays Global Investors, or Vanguard’s ETFs.