If you wonder whether the comparisons most often made between ETFs (exchange traded funds) and mutual funds are done without bias, you would be wrong. To understand why these traded index funds continue sell their attributes based on cost alone is to miss the point. While they do have very low fees, as all passively traded funds should, the believers in this investment tool trumpet their attributes but do so not by comparing them to the benchmarks they mimic but to a completely different type of mutual fund, the actively traded variety.
The actively traded mutual fund can be costly. The reasons for these costs are often quite simple to grasp. Actively traded mutual funds incur additional costs due to trading more frequently, the research required to make those trades, the assumed risk involved and of course the increased management of those portfolios. Although it is common practice to use benchmarks as a way of determining performance of actively managed mutual funds, it is not often indicative of what the fund is attempting to accomplish and how many underlying securities are in the portfolio.
Actively traded mutual funds own only a portion of the benchmark (indexes such as the Russell 2000 or 3000, the S&P 500, or total market). These funds use benchmarks to identify which portion of the marketplace they invest, in the hope that savvy investors understand that owning a basket of stocks based on those benchmark indexes is merely a guide to what the fund’s charter specifies. If they invest in small cap stocks, the fund will use the Russell 2000 but do so hoping the investor in these funds realizes that not all comparables apply.
But those who suggest that the ETF, which is traded actively much like a stock, ignore certain characteristics of the product. For instance, you will need a broker to purchase an ETF. The cost of buying in and selling is often never mentioned as a real cost in the product. Because ETFs are often used as a parking spot for investors who have become skeptical or seek some exposure to a marketplace they would otherwise consider too risky, these products can incur additional costs as investors move in and out more frequently than they would had they simply let an actively managed fund manager do it for them.
Does this mean that ETFs are something to avoid? Not really. But investors need to have a good understanding of who they are and why they have chosen these funds instead of an old-fashioned index fund (also low in overall fees and also passively managed). If you trade an ETF frequently, you are more or less deluding yourself as to the savings.
Comparing an ETf to an actively managed fund might be akin to comparing the calories burned by a person sitting compared to a person running. Of course, sitting reserves a great deal of fuel and because of that, the cost of replenishing that energy is low. Whereas the running person must maintain their energy at a cost that is higher. To take the analogy just a bit further, who do you think will arrive at their goal first?
And despite Jared Cummans claim: “While a few basis points here and there may not seem like much in the short term, these differences in management fees can translate into big dollar amounts over longer periods of time” he fails to communicate the need for the investor to be as passive as the ETF you are investing in. In other words, if you are not going to buy an ETF and hold it for the suggested long-term, the savings will quickly evaporate. You can read Mr. Cummans decidedly biased comparatives here.
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