Why many investors prefer ETFs over conventional mutual funds

ETF stands for exchange-traded funds, which are index funds that trade similar to stocks. As such, ETFs make for interesting investment options. The ETF charges are often — but not always — lower than index funds, and they may charge you less in taxes.

Exchange-traded funds started trading more than a decade ago, but recently they have been gaining popularity as compared to more mature mutual funds options.

An ETF’s fundamental net asset value is weighed by taking the present value of the fund’s net assets (the value of all securities inside minus liabilities) divided by the sum of total shares outstanding. The net asset value, or NAV, is printed every 15 seconds all through the trading day. But the NAV of an ETF isn’t necessarily its market price.

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When you buy shares of a conventional mutual fund, the NAV serves much similar to a stock price — it’s the cost at which shares are purchased or sold from the fund company. At a conventional fund, the net asset value is fixed at the end of each trading day.

As noted, ETFs work quite differently. Since ETFs trade similarly to a stock, you purchase and sell shares on an exchange at a cost determined by supply and demand. That’s why an ETF’s market cost can vary from its NAV. The way Exchange-traded fund shares are structured helps keep the space between those two figures quite tight.

Here Tamir Zoltovski (co-founder of Moneta International UAB) shares some of the important reasons why investors maylike ETFs:

Diversification:

Similar to index funds, ETFs offer a competent way to invest in a precise part of the stock or bond market (say, small-cap stocks, energy or rising markets), or in a wide spectrum of assets.

Costs:

Many good Exchange Traded Funds have very low fees as compared to the conventional mutual funds.

Open Book: 

Again, since they follow an index, you usually recognize precisely what’s inside an ETF. With conventional mutual funds, holdings are generally revealed with a long holdup and only occasionally all over the year (mutual funds, which track a particular index, are the exception here).

Ease of use: 

ETFs may be purchased or sold at any time during the day, just similar to stocks. Mutual funds, in contrast, are valued only once at the end of each trading day. For long-term investment, this doesn’t necessarily matter. It is good to know, however, that you can generally trade an ETF at any time during the trading day.

There is a little catch. Since ETFs trade similar to stocks, buyers have to a brokerage commission every time they purchase or sell shares. (Online brokerage charges vary, usually depending on the broker.) Those charges add up rapidly, especially if you are purchasing more shares each month. You must do the research and understand your own investing behavior and capabilities when deicing whether to invest in ETFs.