Advisers are always looking for the best investment solutions for their clients. When looking for professionally managed fund options, mutual funds and ETFs are generally the two main options that are widely available to advisers.
Both have benefits and drawbacks both can have a place in your client’s portfolios.
ETFs have gained in popularity and traction with investors of all types since their introduction over 20 years ago. ETFs are similar to mutual funds in that they pool investor’s money together within a fund. A key difference is that ETFs are traded like stocks all during the trading day on the various stock exchanges.
Some potential advantages of ETFs for advisers and their clients include:
- Transparency. ETFs disclose their holdings on a daily basis, mutual funds generally only do this a couple of times per year.
- Low costs. Index ETFs are the most prevalent type of ETF and many of these funds have ultra-low costs.
- Liquidity. In many cases, ETFs can be more liquid than even the underlying asset class in which they invest. For example, bond ETFs in some cases are more liquid than some of the underlying bonds held in the ETF.
- Additionally, since ETFs are traded like stocks, you can use tools like stop orders, limit orders and stop-limit orders. These types of orders are a handy way to limit losses in all types of market environment, they can be especially useful in these volatile times.
- Like stocks, ETFs can also be purchased on margin if that is an issue for your client.
Mutual funds have been around for years and as an adviser they are quite familiar to you and your clients. There are a number of varieties of mutual funds including both actively managed and passive index products. Fee structures vary widely as well. Additionally, open-end mutual funds trades are executed at the end of the trading day.
Closed-end mutual funds are another variety, they trade on the exchanges much like ETFs and stocks. Unlike regular open-end funds there are a finite number of shares created so there isn’t the option to purchase shares by simply sending in money.
Additionally, the structure of closed-end funds can result in steep discounts or premiums between the net asset value of the underlying shares and the price at which your client actually purchases the shares. For the rest of our discussion here, the focus will be on open-end funds when mentioning mutual funds.
Mutual funds are often the investment of choice in your client’s workplace retirement plans. Additionally, there are very few choices for actively managed funds among ETFs if you are looking for a particular style of active manager or a specific manager.
Deciding Between ETFs and Mutual Funds
Thankfully, this doesn’t have to be an either/or decision. It's perfectly fine to use both in combination to achieve the investment mix and allocation you are seeking for your client. A few considerations:
- For clients with taxable investments ETFs are often more tax-efficient.
- Mutual funds can often be purchased on a no-load basis and with no or very low transaction fees based on the platform you use for your client’s investments.
- Mutual funds can experience a performance drag in some cases when managers are experiencing high levels of investor redemptions forcing them to hold higher levels of cash than they otherwise might.
- If your client needs to use stop orders, limit orders or to buy on margin then ETFs are the best route.
- For clients who want to invest set amounts on a regular and automatic basis, mutual funds are probably the best choice as this type of investment arrangement is a staple of mutual funds. The ability to invest by dollar amount in mutual funds versus the need to buy whole shares in ETFs in most cases tilts this in favor of mutual funds.
Both mutual funds and ETFs offer advantages in general and by specific fund. Using both to meet the investing needs of your clients is a best practice strategy for advisers. Both mutual funds and ETFs offer some unique options in addition to the many similarities they have on other types of investments.