Reducing Investment Risk With ETFs

Exchange-Traded Funds Are a Safer Alternative to Stock Investing

As an indexed security, exchange-traded funds (ETFs) are still susceptible to market fluctuations. However, they are a portfolio of investments, which provides greater diversification for the investor than owning an individual stock or bond. The funds are diversified by the ETF’s management and it takes the selection headache away from the investor.

By owning an indexed stock ETF, investors get the diversification of an index fund as well as the ability to sell short, buy on margin, and purchase as little as one share (there are no minimum deposit requirements).

How Are ETFs different than Mutual Funds

ETFs are comparable to Mutual Funds, but they have a few essential differences:1

ETFs Mutual Funds
Trade during trading day Trade at closing NAV
Low operating expenses Operating expenses vary
No investment minimums Most have investment minimums
Tax-efficient Less tax-efficient
No sales loads May have sales load

ETFs tend to have lower average costs and are more tax efficient. Although similar in many ways, ETFs differ from mutual funds because shares trade like common stock on an exchange. The price of an ETF’s shares will change throughout the day as they are bought and sold. The largest ETFs typically have higher average daily volume and lower fees than mutual fund shares which makes them an attractive alternative for individual investors.

Other Considerations for ETF Investments:

Trading Fees

Just like stocks, ETFs charge trading fees when buying or selling3. There is one class of mutual funds that is more advantageous, in regards to trading fees and that is no-load mutual funds. However, some carriers also provide ETFs without fees.

ETF Capital Gains Tax

For the most part, ETF managers are able to manage the secondary market transactions in a manner that minimizes the chances of an in-fund capital gains event. It is rare for an index-based ETF to pay out a capital gain; when it does occur it is usually due to some special unforeseen circumstance.

Of course, investors who realize a capital gain after selling an ETF are subject to the capital gains tax

Tax Loss Harvesting is More Difficult

Although stocks are more risky, they are easier to sell when their price goes down. An ETF investor has to buy or sell the entire combination of ETF investments, because ETF managers determine when adjustments are made to the portfolio.

What Type of ETFs Are the Best?

In a general sense, many of our investors prefer to utilize index-based, lost cost exchange traded funds. However, it is important to consider potential fees, the investment strength of the desired ETF and your personal financial situation.

Contact me for more information on ETF investment options, or to evaluate if an ETF is right for your: (512) 638-9499.

  1. Stan Murray. Investopedia. Apr. 15, 2009. “What is the difference between exchange-traded funds and mutual funds?” https://www.investopedia.com/ask/answers/09/mutual-fund-etf.asp. Accessed Jan. 18, 2019.
  2. Stephen Gruber-Miller. Jan. 11, 2009. “Employees sue Transamerica, claim poor management cost them millions in retirement accounts.” https://www.desmoinesregister.com/story/news/crime-and-courts/2019/01/11/transamerica-cedar-rapids-employees-class-action-lawsuit-claim-lost-millions-retirement-accounts/2467194002/. Accessed Jan. 18, 2019.
  3. Emily Norris. Nov. 1, 2018. “11 ETF Flaws You Shouldn’t Overlook.” https://www.investopedia.com/articles/mutualfund/07/etf_downside.asp. Accessed Jan. 18, 2019.