Exchange Traded Funds (ETF) are a new rising investment vehicle in a market littered with stocks, mutual funds, index funds and bonds.   While there are many wild misconceptions of ETFs out there, a little knowledge on the strengths and weaknesses of ETFs will behoove all investors out there. Simply put, ETFs are a collection of stocks or bonds, much like a mutual fund.  This collection can be made of companies within a certain industry, size or even market.  For each mutual fund, there is most likely an ETF that very closely resembles the securities within the mutual fund.  However, there are a few key differences between ETFs and mutual fund.  It is difficult to say that in all situations, one investment vehicle overbearingly trumps the other.  But given an investors specific circumstance, we can pinpoint what type of investment will be most beneficial.
One of the key differences between ETFs and mutual funds is an ETFs ability to trade in and out throughout the day similarly to individual stocks.  Mutual funds on the other hand, do not offer the same flexibility when it comes to trading.  This allows ETF traders the ability to manipulate a tangent investment all throughout the trading day.
Another difference between ETFs and mutual funds lies with the expense ratio.  An expense ratio is basically the percentage of costs incurred for annual expenses.  ETFs generally boast a considerably lower expense ratio when compared to mutual funds.  While the difference between an ETFs expense ratio of 0.1 and a mutual funds expense ratio of 1.5 may not seem significant on paper, it is a considerable amount when compounded over a lifetime of investing.
There are different costs that are incurred to buy into ETFs and mutual funds.  Since ETFs trade like stocks, they incur costs similarly.  They are purchased through a brokerage (Ameritrade, Vanguard, eTrade etc) and therefore are charged brokerage fees for each transaction.  This generally ranges from four to twelve dollars.  On the other hand, mutual funds are charged through various loads.  Loads can either be charged in the form of a front load or back-end load.   Front loads are when a percentage of the initial investment funds are taken out while back-end loads are when a percentage of the investment is taken when selling the mutual fund.  There are also mutual funds that offer no loads.  Regardless, all of these ETFs and mutual funds still charge an expense ratio as previously discussed.  For someone who frequently trades in and out of investments on a daily basis, ETF brokerage fees may start to get pricier than a no-load mutual fund would.
The last difference between ETFs and mutual funds is the potential tax implications.  Mutual funds are actively managed funds that generally have a higher turnover ratio than ETFs.  Therefore, many mutual fund owners get stuck with taxable capital gain distributions.  ETFs have an advantage because it has the flexibility to distribute securities to shareholder and in turn avoiding shareholders from having to realize capital gains.
By learning what an ETF is and how it compares to other investment opportunities within the market, investors have another tool in their tool belt to utilize when beneficial.  ETFs can be a very valuable addition to one’s portfolio and ultimate quest to make money.