When deciding whether to invest in ETFs or mutual funds, it may help to know whether you're an active or buy-and-hold investor.
Each financial product comes with its own unique set of advantages and disadvantages. But these aren’t solely attributable to the product itself. They also have a lot to do with the individual investor—namely, how he or she uses the product.
This scenario is especially true when comparing exchange-traded funds (ETFs) and mutual funds. Suppose you’ve gone over the basic features, noted the main differences, and mulled over the pros and cons of each product, but you still can’t decide between the two.
What if you approached the problem from a different angle, one that focuses less on the products and more on your own preferences and tendencies as an investor? You might want to begin by asking a simple set of questions: “Am I more of a buy-and-hold investor or an active participant and which products—ETFs or mutual funds—might better align with my investment style?”
In case you’re not familiar with either term, here’s a brief description.
Assuming you’re familiar with the features that differentiate ETFs and mutual funds, let’s see how both products might enhance or limit the tendencies inherent to both general investment styles. Here’s the skinny:
ETFs for the Buy-and-Hold Investor
Many ETFs are indexed to a benchmark, making them a popular choice for the self-directed buy-and-hold type of investor. The products are also flexible enough to provide both concentrated and diversified index exposures. Plus, TD Ameritrade clients can access over 300 commission-free ETF products offered by eight leading providers.
Caveat: If you don’t feel you have the discipline to stay the course during periods of market volatility, then perhaps a do-it-yourself approach to buy-and-hold investing might not be the best fit.
Mutual Funds for the Buy-and-Hold Investor
As they may be inclined to do with ETFs, buy-and-hold investors may focus on index-based mutual funds. Other mutual funds allow you to benefit from the services of a professional fund manager, whose job is to know the ins and outs of constructing and rebalancing a portfolio. Fund managers apply their knowledge and understanding of markets and market sectors in the context of the economic conditions to attempt to optimize the portfolio mix within the confines of the fund’s objectives. TD Ameritrade clients can access more than 13,000 mutual funds, including several hundred no-transaction-fee (NTF) mutual funds.
Caveat: Professional management costs money. In addition to paying management fees, you may also end up paying a larger tax bill, in the case of funds with high asset turnovers. This can erode your principal invested.
ETFs for the Active Trader
Because of their intraday trading flexibility, lower fees than managed mutual funds, and range of market exposures—from narrow to wide—ETFs generally are considered by the active participant.
Caveat: Active trading can be difficult and tricky. It often entails timing the market, which can be challenging at best and can lead to missing opportunities, not to mention additional transaction costs. And those commission-free products? Because they’re typically meant for buy-and-hold investors, they are typically subject to minimum holding periods.
Mutual Funds for the Active Trader
Mutual funds can only be bought and sold at the end of a trading day, at the daily net asset value (NAV). Considering this lack of trading flexibility, mutual funds might not be inherently compatible with a more active investment approach. Many investors thus view mutual funds as long-term investment products.
Caveat: Clients do not pay a load fee for most mutual funds available on the TD Ameritrade platform, and many come with no transaction fees. Plus, many employer-sponsored plans allow participants a certain number of transactions per month for free, for those interested in rejiggering their investment lineup. So if you’ve considered all the variables and are leaning toward mutual fund investing, the once-a-day valuation shouldn’t necessarily deter you from choosing mutual funds, even if you plan to take a more active approach.
When deciding between ETFs and mutual funds, consider your investment style. And of course, consider whether your investment style and product of choice aligns with your overall investment goals, financial resources, and risk tolerance.
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