ETFs Consistently Beat Mutual Funds?

A friend of mine recently askedwhether there wasn't a betteralternative to investing in mutualfunds. The best choicecurrently available is a relatively new typeof security called an exchange-tradedfund (ETF). An ETF represents a specificindex such as the S&P 500, and likeindex mutual funds, expenses are verylow. The Vanguard S&P 500 fundcharges 0.18% annually; the ETF versioncharges a meager 0.09% annually.

More Efficient

In addition to having smaller fees,ETFs are more tax-efficient than mutualfunds. By law, mutual funds are requiredto distribute at least 95% of all net realizedcapital gains each year to theirinvestors by a certain date. ETFs avoidthis problem altogether, and you only recognizegains when you sell an ETF inwhich you have made money. With amutual fund, it is possible to have lossesfor the year, yet still get hit with taxablegains on fund distributions.

Frequent Trades

Another advantage of ETFs overmutual funds is that you can trade ETFsthroughout the day, whereas mutualfunds settle at the close of the day's prices.In today's fast-paced, global environment,dramatic market changes can happen inthe course of a single day. Intradaily tradingcan be an important benefit.

Finally, many mutual funds, evenno-load funds, charge a redemption feewhen you sell your fund within a certainperiod of time from purchase (typically90 days). ETFs do not have suchrestrictions. This allows the investor toremain mobile and responsive to rapidlychanging events. Now, I believe inhaving a long-term investment strategy,but it's important that you maintain theflexibility to make changes should extraordinarycircumstances arise. ETFsgive you that flexible option.

You now have access to over 120different types of ETFs, allowing you tobe very strategic in your investing, whilestill maintaining significant securitydiversification. I know many investorswho use ETFs extensively in their portfolios,and they have found them to bea better choice than mutual funds inmany circumstances. For more informationabout ETFs, visit www.welchgroup. com. At the bottom of the HomePage, click on "Cool Links," and then on"Exchange-Traded Funds."

Stewart H. Welch III, founder ofthe Welch Group, has been rated1 of the nation's top financial advisorsby Money and Worth. Hewelcomes questions or commentsfrom readers at 800-709-7100 orwww.welchgroup.com. Reprinted with permissionfrom the Birmingham Post Herald. This articlewas taken, in part, from J. K. Lasser's NewRules for Estate and Tax Planning (John Wiley &Sons; 2001), coauthored by Harold Apolinsky,Esq, and Mr. Welch.