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Investing fund research 02: Mutual Fund vs. ETF : Which is better to invest?
by 趙永祥 2019-04-05 21:11:38, Reply(0), Views(229)



Investing fund research 02:

Mutual Fund vs. ETF : Which is better to invest?


I. Types of Mutual Funds

There are two main legal classifications for mutual funds:

1. Open-Ended Funds. 

  • These funds dominate the mutual fund marketplace in volume and assets under management. With open-ended funds, the purchase and sale of fund shares take place directly between investors and the fund company. 

  • There's no limit to the number of shares the fund can issue. So, as more investors buy into the fund, more shares are issued. Federal regulations require a daily valuation process, called marking to market, which subsequently adjusts the fund's per-share price to reflect changes in portfolio (asset) value. The value of an individual's shares is not affected by the number of shares outstanding.


  • 2. Closed-End Funds. 
  • These funds issue only a specific number of shares and do not issue new shares as investor demand grows. Prices are not determined by the net asset value (NAV) of the fund but are driven by investor demand. Purchases of shares are often made at a premium or discount to NAV.


II. Exchange-Traded Funds

ETFs can cost far less for an entry position—as little as the cost of one share, plus fees or commissions. An ETF is created or redeemed in large lots by institutional investors and the shares trade throughout the day between investors like a stock. Like a stock, ETFs can be sold short. 

Those provisions are important to traders and speculators, but of little interest to long-term investors. But because ETFs are priced continuously by the market, there is the potential for trading to take place at a price other than the true NAV, which may introduce the opportunity for arbitrage.

ETFs offer tax advantages to investors. As passively managed portfolios, ETFs (and index funds) tend to realize fewer capital gains than actively managed mutual funds.

Keynotes:

ETFs are more tax efficient than mutual funds because of the way they are created and redeemed.

For example, suppose an investor redeems $50,000 from a traditional Standard & Poor's 500 Index (S&P 500) fund. To pay the investor, the fund must sell $50,000 worth of stock. If appreciated stocks are sold to free up the cash for the investor, the fund captures that capital gain, which is distributed to shareholders before year-end. As a result, shareholders pay the taxes for the turnover within the fund. If an ETF shareholder wishes to redeem $50,000, the ETF doesn't sell any stock in the portfolio. Instead, it offers shareholders "in-kind redemptions," which limit the possibility of paying capital gains.


There are three legal classifications for ETFs:

1. Exchange-Traded Open-End Index Mutual Fund. 

  • This fund is registered under the SEC's Investment Company Act of 1940, whereby dividends are reinvested on the day of receipt and paid to shareholders in cash every quarter. Securities lending is allowed and derivatives may be used in the fund.

  • 2. Exchange-Traded Unit Investment Trust (UIT). 

  • Exchange-traded UITs also are governed by the Investment Company Act of 1940, but these must attempt to fully replicate their specific indexes, limit investments in a single issue to 25 percent or less, and set additional weighting limits for diversified and nondiversified funds. UITs do not automatically reinvest dividends, but pay cash dividends quarterly. Some examples of this structure include the QQQQ and Dow DIAMONDS (DIA).


  • 3. Exchange-Traded Grantor Trust. 

  • This type of ETF bears a strong resemblance to a closed-ended fund, but an investor owns the underlying shares in the companies in which the ETF is invested. This includes having the voting rights associated with being a shareholder. The composition of the fund does not change, though. Dividends are not reinvested, but are paid directly to shareholders. Investors must trade in 100-share lots. Holding company depository receipts (HOLDRs) is one example of this type of ETF.

Conclusion

  • Mutual funds usually are actively managed to buy or sell assets within the fund in an attempt to beat the market and help investors profit.

  • ETFs typically track a specific market index and can be bought and sold like stocks.

  • Factor in the different fee structures and tax implications of these two investment choices.

Written by Dr. Chao Yuang Shiang (趙永祥 博士)

 Faculty, Dep. of Finance, Nan Hua university

 (南華大學財務金融學系暨財務管理研究所 專任助理教授)

 5- April- 2019