As investors seek alternatives to mutual funds, Exchange-traded funds (ETFs) are becoming a popular option. Considered to be a low-risk investment due to their lower-costs and increased diversification, ETFs have taken the financial market by storm.
According to veteran investor Darren Herft, “Exchange-traded funds or ETFs present benefits to both institutions and individual investors.”
The Australian entrepreneur thinks that the basket of assets offered by ETFs provides investors with a uniquely diverse portfolio.
“A single exchange-traded fund exposes an investor to a group of equities, market segments, or styles. Exchange-traded funds track a wider range of stocks than mutual funds,” says Darren Herft.
In addition to diversification, ETFs bring the trading liquidity of equity to the table. Their trade price is updated throughout the day as opposed to open-ended mutual funds that are priced at the end of the day.
Darren Herft says, “This allows investors to manage risk better by trading futures and options like stocks.”
As exchange-traded funds trade like stocks, they allow investors to compare them to their daily price to their indexed sector or commodity. There are numerous websites that offer great interfaces and provide mobile apps to track investments.
ETFs bypass all the expenses that encumber mutual funds such as management fees, shareholder accounting expenses at the fund level, marketing, as well as load fees for sales and distribution.
“Exchange-traded funds have a much lower expense ratio compared to actively managed funds as they’re managed passively,” says Darren Herft.
Another advantage of ETFs is that the dividends of companies in open-ended Exchange-traded funds are reinvested immediately as opposed to index mutual funds.
Darren Herft believes that Exchange-traded funds could prove to be more tax-efficient. “Due to their passively managed portfolios, Exchange-traded funds have a tendency to realize fewer capital gains than mutual funds,” says Herft.
The AFL aficionado explains that this is because mutual funds are required to dispense capital gains to shareholders in case their manager sells for a profit. The funds realized from such a sale are in proportion to the investors holding and are taxable.
“Even if some mutual fund holders liquidate before the date of record, the remaining holders divide up the capital gain and are liable to pay taxes even if the fund sees an overall decrease in value,” says Herft.
As exchange-traded funds are traded based on supply and demand, there is a lower possibility of their share prices being lower or higher than their value.
“ETFs trade at price close to their underlying securities,” informs Herft.
While the veteran investor believes that ETFs can provide a great opportunity for individual investors to build a diversified portfolio, he is also cautious about blind optimism.
Holding ETFs can open an investor to unique risks, such as special considerations regarding taxation depending upon the type of ETF held.
Herft says, “No investment is perfect”.
“ETFs have their shortcomings, and it is important for investors to identify the benefits and risks associated with these securities to navigate between risk and reward,” adds Herft.
