Benefits of ETFs - Fidelity (2024)

For nearly a century, traditional mutual funds have offered many advantages over building a portfolio one security at a time. Mutual funds provide investors instant diversification, professional management, relative low cost, and daily liquidity.

Exchange-traded funds (ETFs) take the benefits of mutual fund investing to the next level. ETFs can offer lower operating costs than traditional open-end funds, flexible trading, greater transparency, and better tax efficiency in taxable accounts. As with all investment choices there are elements to review when making an investment decision. Most informed financial experts agree that the pluses of ETFs overshadow the minuses by a sizable margin.

Positive aspects of ETFs

ETFs have several advantages for investors considering this vehicle. The 4 most prominent advantages are trading flexibility, portfolio diversification and risk management, lower costs versus like mutual funds, and potential tax benefits.

Trading flexibility

Traditional open-end mutual fund shares are traded only once per day after the markets close. All trading is done with the mutual fund company that issues the shares. Investors must wait until the end of the day when the fund net asset value (NAV) is announced before knowing what price they paid for new shares when buying that day and the price they will receive for shares they sold that day. Once-per-day trading is fine for most long-term investors, but some people require greater flexibility.

ETFs are bought and sold during the day when the markets are open. The pricing of ETF shares is continuous during normal exchange hours. Share prices vary throughout the day, based on the changing intraday value of the underlying assets in the fund. ETF investors know within moments how much they paid to buy shares and how much they received after selling.

The intraday trading of ETF shares makes it easy to move money between specific asset classes, such as stocks, bonds, or commodities.

Trading traditional open-end mutual funds is more challenging and can take several days. First, there is typically a 4:00 pm Eastern standard time cutoff for placing open-end share trades. That means you do not know what the NAV price will be at the end of the day. It is impossible to know exactly how much you will receive when selling shares of one open-end fund or know how much you should buy of another open-end fund.

The trade order flexibility of ETFs also gives investors the benefit of making timely investment decisions and placing orders in a variety of ways. Investing in ETF shares has all the trade combinations of investing in common stocks, including limit orders and stop-limit orders and options. ETFs can also be purchased on margin by borrowing money from a broker. Every brokerage firm has tutorials on trade order types and requirements for borrowing on margin.

Short selling is also available to ETF investors.

Portfolio diversification and risk management

Investors may wish to quickly gain portfolio exposure to specific sectors, styles, industries, or countries but do not have expertise in those areas. Given the wide variety of sector, style, industry, and country categories available, ETF shares may be able to provide an investor easy exposure to a specific desired market segment.

ETFs are now traded on virtually every major asset class, commodity, and currency in the world. Moreover, innovative new ETF structures embody a particular investment or trading strategy. For example, through ETFs an investor can buy or sell stock market volatility or invest on a continuous basis in the highest yielding currencies in the world.

In certain situations, an investor may have significant risk in a particular sector but cannot diversify that risk because of restrictions or taxes. In that case, the person can short an industry-sector ETF or buy an ETF that shorts an industry for them.

For example, an investor may have a large number of restricted shares in the technology industry. In that situation, the person may want to short shares of a technology sector ETF. That would reduce one's overall risk exposure to a downturn in that sector.

Lower costs

Operating expenses are incurred by all managed funds regardless of the structure. Those costs include, but are not limited to, portfolio management fees, custody costs, administrative expenses, marketing expenses, and distribution. Costs historically have been very important in forecasting returns. In general, the lower the cost of investing in a fund, the higher the expected return for that fund.

ETF operation costs can be streamlined compared to open-end mutual funds. Lower costs are a result of client service–related expenses being passed on to the brokerage firms that hold the exchange-traded securities in customer accounts. Additionally, ETFs do not charge a 12b-1 fee, the annual marketing fee.

Brokerage companies issue monthly statements, annual tax reports, quarterly reports, and 1099s, and ETFs are generally included in those statements. The reduced administrative burden of service and record keeping for thousands of individual clients means ETF companies have a lower overhead, and at least part of that savings is passed on to individual investors in the form of lower fund expenses.

Another cost savings for ETF shares is the absence of mutual fund redemption fees. Shareholders in ETFs avoid the short-term redemption fees that are charged on some open-end funds. For example, the Vanguard REIT Index Fund Investor Shares () has a redemption fee of 1% if held for less than one year. The Vanguard REIT ETF () is the exact same portfolio and has no redemption fee.

Tax benefits

ETFs have a major tax advantage compared to mutual funds. Due to structural differences, mutual funds typically incur more capital gains taxes than ETFs. Moreover, capital gains tax on an ETF is incurred only upon the sale of the ETF by the investor, whereas mutual funds pass on capital gains taxes to investors through the life of the investment. In short, ETFs have lower capital gains and they are payable only upon sales of the ETF.

Benefits of ETFs - Fidelity (2024)

FAQs

What are the 4 benefits of ETFs? ›

Positive aspects of ETFs

The 4 most prominent advantages are trading flexibility, portfolio diversification and risk management, lower costs versus like mutual funds, and potential tax benefits.

Is Fidelity good for ETF? ›

Fidelity's actively managed ETFs seek better investing outcomes* and offer trading flexibility along with potential tax efficiency.

What are some advantages of ETFs quizlet? ›

Exchange-traded funds can be traded during the day, just as the stocks they represent. They are most tax effective, in that they do not have as many distributions. They have much lower transaction costs. They also do not require load charges, management fees, and minimum investment amounts.

What are the positives and negatives of ETF? ›

In addition, ETFs tend to have much lower expense ratios compared to actively managed funds, can be more tax-efficient, and offer the option to immediately reinvest dividends. Still, unique risks can arise from holding ETFs as well as tax considerations, depending on the type of ETF.

What is ETF and its benefits? ›

An Exchange Traded Fund (ETF) is a collection of marketable securities that track an underlying index. An ETF is a collection of securities such as stocks, bonds, commodities, or a basket of assets like an index fund. It combines the features of different investment options, such as mutual funds and stocks.

Why is ETF not a good investment? ›

ETFs are subject to market fluctuation and the risks of their underlying investments. ETFs are subject to management fees and other expenses. Unlike mutual funds, ETF shares are bought and sold at market price, which may be higher or lower than their NAV, and are not individually redeemed from the fund.

Does Fidelity charge a fee for ETF? ›

1. $0.00 commission applies to online U.S. equity trades, exchange-traded funds (ETFs) and options (+ $ 0.65 per contract fee) in a Fidelity retail account only for Fidelity Brokerage Services LLC retail clients. Sell orders are subject to an activity assessment fee (from $0.01 to $0.03 per $1,000 of principal).

How does Fidelity ETF work? ›

How ETFs work. An ETF is bought and sold like a company stock during the day when the stock exchanges are open. Just like a stock, an ETF has a ticker symbol and intraday price data can be easily obtained during the course of the trading day.

Do ETFs trade free at Fidelity? ›

ETFs. Our diverse offering includes 3 active equity ETFs*, 11 Fidelity sector ETFs, 5 Fidelity bond ETFs, and 14 Fidelity factor ETFs. All online ETF trades are $0.

What are the benefits of ETFs vs mutual funds? ›

ETFs offer numerous advantages including diversification, liquidity, and lower expenses compared to many mutual funds. They can also help minimize capital gains taxes. But these benefits can be offset by some downsides that include potentially lower returns with higher intraday volatility.

What is the primary disadvantage of an ETF? ›

Buying high and selling low

At any given time, the spread on an ETF may be high, and the market price of shares may not correspond to the intraday value of the underlying securities. Those are not good times to transact business.

Are ETFs good for short-term investing? ›

With attractive yields available in short-term bond markets, investors seeking an alternative to cash may consider using ETFs to add income and help keep pace with inflation.

Are ETFs good for long-term investing? ›

ETFs can form a diverse foundation

The big advantage with ETFs is they offer an unmatched choice of assets, markets, and risk levels. That means there is probably an ETF to match your long-term needs at whatever life stage you are at. ETFs can help you build a strong foundation for your long-term investment portfolio.

Why are ETFs more efficient? ›

Although similar to mutual funds, equity ETFs are generally more tax-efficient because they tend not to distribute a lot of capital gains.

What is the downside of ETFs? ›

For instance, some ETFs may come with fees, others might stray from the value of the underlying asset, ETFs are not always optimized for taxes, and of course — like any investment — ETFs also come with risk.

What is the 3 ETF strategy? ›

A three-fund portfolio is a portfolio which uses only basic asset classes — usually a domestic stock "total market" index fund, an international stock "total market" index fund and a bond "total market" index fund.

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