Dockside Chat - ETF vs. Mutual Fund

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View Full Version : ETF vs. Mutual Fund


LI Sound Grunt
04-05-2008, 10:51 AM
Another stupid money question from a financial idiot. :)

Thye have ETFs and Mutual Funds that track the DJ, S and P 500 and other indexes.

Can someone explain in brief, simple English, why one is better than the other - both taxwise and in terms of potential profits (considering commissions and fees and such).

The info I found online was confusing and I think the info from Mutual Fund web-sites like Fidelity and such may be biased.

Thanks


dssmith
04-05-2008, 11:23 AM
Mutual Fund is managed by paid managers. Hence the .75-2% annual fee.
EFT is a portfolio that is backed the the stocks in the sector you purchase. No financial mgt fee. Hence cost of ownership is lower for the EFT.

Mutual funds are valued at the end of each day. (Computer adds up the closing price/value of each holding and that tells the Mutual Fund "how much they got/gained/lost." Then if you wish to sell your shares you have to await for valuation/sale of the assets. Mutual Funds are not as liquid as EFT's

EFT's are "traded" thus the valuation of your money is constant decided by the intraday trading price. (Like a stock) You can get into an EFT in the morning, and sell it at noon. (Kindof)

There are all kinds of Mutual Funds. Some invest in only left handed companies with 1/2 price sales on Saturdays. There are almost an infinite kind of Mutual funds.

Now, Most EFT's are sector based. You like gold--There's and EFT that will put you exclusively in gold shares. (No cash positions/no hedge) Same with Health Care/Automotive/DIJA etc.

Sorry I can't be more specific. I'm just as chicken as anybody about moving into EFT's, but I believe the Exchange Traded Funds are essentially collections of stocks, in a basket, that trade like stocks.

Know that like Mutual Funds, gains or losses from either EFT or Mutual Funds are taxed by duration. Short Term/Long Term etc. Mutual Funds will buy and sell in their portfolio and generate long and short term gains and losses and pass them on to the owners of the funds. These are your gains/losses for tax purposes.

I don't know what EFT's do with their dividends, but I suspect they have to pass them on to "owners" of the shares, but I don't know how they determine owners of record. Someone help me out here.

LI Sound Grunt
04-05-2008, 12:04 PM
Thanks ds

Ok thanks!

So basically they both have yearly tax consequences even if you do not sell them?


dssmith
04-05-2008, 12:10 PM
I'm going to guess you are correct. If you get a distribution/loss, then you will report that on your 1040. Whether a Mutual Fund, or and EFT.

Caveat---I haven't owned and EFT, but that's what I suppose the IRS says. Again, like a stock, I don't know how EFT's account for dividends, the stocks they own going ex-dividend, and who/when gets assigned ownership of the dividend flow. I think the only way to know is to read a prospectus from an EFT offering.

(Make sure you have the entire night ahead of you... I can't hardly stay awake reading a prospectus)

flattie
04-05-2008, 12:13 PM
There are pro's and con's with both.

ETF's are all tied to the performance of an index (broad based like S&P 500) or sector (just tech stocks) or even commodities. They aren't actively managed except to the extent that someone is making sure that the ETF is tracking its benchmark index as closely as possible. As such their annual expense ratios are pretty low - the S&P 500 ETF, symbol SPY, has annual expenses of around .12%. ETF's will pass through dividends and any capital gains they might realize(just like a mutual fund) - they would realize cap gains if the index changed and the ETF had to buy/sell stocks to reflect the change and in doing so incurred a cap gain. That said, the broad based indexes (S&P 500, Dow, etc) tend to have fairly low turnover (buying and selling) vs actively managed mutual funds so they have less chance to incur cap gains. They are traded like stock, so you will pay a brokerage commission each and every time you buy/sell. Like stock, many have listed options traded and the ETF itself can be bought/sold with stop, stop/limit, limit, market orders etc. - in short pretty flexible as fair as targeting a purchase or sales price.

Mutual funds can either be actively managed or passive/index based. The fairest comparison is to compare index based mutual funds to ETF's. With an active fund you are hoping the fund manager has the ability to be smarter than everyone else and "beat the market". With an index based fund you are looking to simply match the markets performance. Index based mutual funds will have lower annual expenses vs actively managed funds and should be in the neighborhood of what an ETF based on the same index would cost. Many index mutual funds are "no load" funds so you won't pay commissions to buy and sell them. If you are dollar cost averaging (buying a little at a time at regular intervals) you're probably better off using the index mutual funds vs the ETFs since you don't pay commission. When you buy/sell index mutual funds you must place your order before the market close and you won't find out what price you actually bought/sold at until after the market close.

Based on how ETF's create new shares of ETF's its possible that they have a slight tax advantage vs an index mutual fund based on the same index. If an index mutual fund is innundated with sell orders, the fund must sell stock to raise cash to meet redemptions which can cause the fund to realize capital gains which must be paid out to the remaining shareholders at years end. ETF's when faced with massive selling, will see their shares get redeemed on an in kind basis - large institutional investors will turn in 50,000 ETF shares and get back the underlying basket of stocks owned by the ETF. This in kind redemption is not a taxable event for the ETF so the remaining shareholders would not get hit with cap gains simply as a result of other investors in the ETF selling their shares. (Note: the leveraged and inverse leveraged, as well as the commodity based ETF's due to their structure will tend to pay more cap gains than a plain vanilla ETF based on a broad index like the S&P 500).

So in short - if you want to buy a largish quantity in 1 or 2 blocks - you may consider the ETF. If you are investing via dollar cost averaging you most likely will fair better with a no load index fund.

TeamPig
04-05-2008, 12:46 PM
It would be wise to stay in the short end of the Treasury curve for the next several years.

In normal recessions, major indices suffer a 30% decline from their peak. Currently we are only off about 12% from the peak.

I would not feel comfortable calling this a "normal" recession either.

dssmith
04-05-2008, 07:20 PM
Hello Grunt,

Here's a paragraph I ripped off from my Chas. Schwab site.......

ETFs also tend to be more tax-efficient than index funds. One example is the oldest ETF, the S&P 500 Depositary Receipt (SPY). Often abbreviated as SPDR and pronounced "spider," it had average capital gains distributions of less than 0.02% of invested assets during the past 12 years vs. an average 0.35% for the largest three S&P 500® index funds. Another advantage of ETFs is that they are not required to keep return-dampening cash on hand for redemptions, unlike mutual funds....


My investment guru's have lead me to switch my assets to Schwab. Due to the size of my account, and because my investment guys are linked with Schwab--"Schwab Alliance" I'm supposed to pay only $8.95/trade. Seems unbelievable that I could spend $1,000,000 or $1000 for only 9 bucks, but that's what they say it will cost me. I will contact my guys if this is really all it would cost, so don't think I'm trying to pitch Schwab over anyother brokerage. My IRA arrived at Schwab last Monday after 28 years with Merrill Lynch, so don't anyone give a care about which brokerage is "better" than the next.

Merrill treated me great, I only switched to make it easier for my managers.

I'm just illustrating how little the costs/tax consequences of buying/selling EFT's 'might' be compared to mutual funds.

Hope the quote from Schwab is informative.

evensen
04-06-2008, 12:56 AM
The major difference:
buy and sell ETF as quickly and as often as you like.
if you trade mutual funds quickly, you get a polite message... go somewhere else.
The ETF market is expanding very fast.
One can make some nice profits day trading DIA, DXD, SDS, and SSO.

evensen
04-06-2008, 01:04 AM
Scottrade: $7 in, $7 out
I trade 1000, 1200, or 1400 share blocks frequently.
Stay with ETFs that have high volume-- at least 2 million shares traded per day.
I try to get at least $ .50 per share, but will settle for less when needed.
I need a volitile market for this current system to work.
I NEVER own them over a weekend.

LI Sound Grunt
04-06-2008, 05:54 AM
Thanks again to all

Very Very Informative!



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