ETFs & ETCs

Boquete: beautiful small town of about 20,000 people in the western highlands of Panama in the province of Chiriqui.

Exchange-traded Funds or ETFs are often a valuable element in any well-rounded portfolio. Because EFTs follow different types of indexes depending on the fund, they offer a diverse means of obtaining growth in broad markets. The availability of EFTs on smaller indexes adds to this diversity, and the ability to buy and sell these types of funds the same as you would a typical stock means that even novice investors can easily find a way to add them to their investment strategy. ETF purchases are subject to the same basic rules as stock purchases. They can fluctuate in value over the course of a trading day just like stocks. The buy-in on funds can be as low as a single share.

Our goal is to build and manage a diversified portfolio of stocks and bonds with the lowest possible fees and the greatest possible tax efficiency. ETFs offer seven advantages over index mutual funds:


Lower cost
ETFs can have lower expense ratios than the lowest-cost index mutual funds. (This excludes transaction commissions and spreads, which we’ll discuss next chapter.) The Barclays i-shares S&P 500 ETF, for example, charges 0.09% a year in fees, compared to about double that for the Vanguard 500 Index Fund. A diversified portfolio of index funds with a common asset allocation costs about 18% less in annual expenses using ETFs than using Vanguard index funds. (The comparison is presented in the next chapter.) A key advantage of ETFs is that since you buy them like a stock in a brokerage account, you can pick the cheapest ETFs from all those available. With index mutual funds, in contrast, you tend to be locked into a singe family of products. Vanguard, for example, does not offer its index funds via the “fund supermarkets” such as Schwab OneSource; if you want to avoid transaction fees, you have to open a Vanguard account. But keeping your portfolio with a single fund provider locks you into that provider’s funds and prevents you from shopping around for the cheapest funds.


Greater tax efficiency
ETFs are more tax efficient than index mutual funds. Index mutual funds themselves are highly tax efficient compared to actively managed mutual funds. But they still make capital gains distributions, which means that investors who hold them in taxable accounts (as opposed to retirement accounts) will get hit with tax bills. In contrast, index ETFs generally make minimal or no capital gains distributions. The broader and more liquid the index, the smaller the capital gains.


Better tax management
Easier tax management is possible with ETFs than index mutual funds. This is a key advantage that can result in significant financial differences, particularly for large accounts. If you buy ETFs in a brokerage account that tracks tax lots and allows you to indentify tax lots for sale, you can sell them with the highest cost-basis, thereby minizing taxable gains. (You can also make charitable gifts of appreciated stock funds with the lowest cost basis.) With index mutual funds, in contrast, your holdings are often reported – and can be sold – using average purchase price only, reducing your ability to realize tax losses (and give away appreciated stock).


(Source: SeekingAlpha Author: David Jackson)
To learn more: ETF Investing Guide: The Seven Advantages of ETFs Over Index Mutual Funds.