At Stock Plan Advisory Group, we prefer Exchange Traded Funds (ETFs) over mutual funds. Here are the benefits and advantages of using ETFs inside your investment portfolio.
The American Stock Exchange petitioned the SEC in 1992 to develop a stand-alone S&P 500 Index-based Exchange Traded Fund, or “ETF.” The first listing of the S&P Depository Receipt, more neatly called the “SPDR”, or “Spider” began trading in 1993 on the AMEX. Later, numerous other ETFs began trading including ETFs such as “Diamonds” for the Dow Jones Industrial Average and “Cubes” for the NASDAQ 100.
Since 1993, ETFs have proliferated both in the number of funds traded, and as to the underlying index they represent. Institutions long known for their mutual funds have joined the increasingly popular method of fund management. While the first ETFs indexed the major markets, today’s ETFs span the globe or slice up the U.S. economy into sectors. ETFs can be affordable and convenient ways to get broad exposure to the market or particular asset classes, as well as to manage risk.
Like a traditional mutual fund, an index ETF is an investment structure that pools the assets of its investors and uses public indexes to invest the money to meet clearly identified objectives. Benefits include:
- Intra-day trading and stock exchange listings
- Low annual expenses
- Diversified securities portfolio
- Low turnover tax efficiency
- Inexpensive to purchase
- ETFs can be held long or short, allowing for portfolio hedging
ETFs – Tax Efficiency
Being low turnover index funds, ETFs can avoid capital gains because unlike traditional funds, ETFs are not capturing gains during the year due to portfolio management. ETFs can also pay off redeeming shareholders with baskets of their underlying portfolios’ stocks instead of cash. Savvy ETF managers also can use that in-kind redemption process to get rid of the stock shares with the biggest unrealized gains. One disadvantage of mutual funds is that they must pay distributions at the end of the year, per IRS rules. ETFs get around this but when you sell your ETF it is subject to normal IRS capital gains rules (ETFs trade like stocks).