ETFs have been ‘a huge growth engine in the fund universe,’ expert says. What to know before you invest


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It’s tempting to follow the crowd when it comes to investing.

While that may not always be wise, experts say one investment vehicle — exchange-traded funds — might be worth a second look now.

“It’s been a huge growth engine in the fund universe,” said Bryan Armour, director of passive strategies research for North America at Morningstar, a provider of investment research.

“That’s led to more products, more strategies, more active managers moving into the ETF space than ever before,” Armour said.

ETFs offer ‘the best of both worlds’

The inflows into year end will create 'a lot of market breadth', says Fundstrat's Tom Lee

ETFs are priced, and can be traded, throughout the day. Mutual fund orders, in contrast, are typically executed once a day, with all investors receiving the same price.

“It’s a mutual fund that trades like a stock,” Todd Rosenbluth, head of research at VettaFi, said of ETFs.

Rosenbluth, a former stock and mutual fund analyst, today focuses specifically on ETFs, which he said “offers the best of both worlds.”

To be sure, while ETFs offer distinct advantages, they also have their downsides.

What you will pay to invest in ETFs

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Tax consequences of investing in ETFs

Mutual funds have yearly distributions where they pass down capital gains and dividends to shareholders.

Mutual fund investors may owe either short- or long-term capital gains on those distributions, depending on how long they have been invested in the fund.

Because long-term capital gains come with lower rates, they’re preferable. However, if an investor has held the fund for a year or less, they will have to pay higher short-term capital gains rates.

While some mutual funds were down substantially in 2022, that prompted investors to redeem their shares, which also triggered capital gains, Armour noted.

Our research has shown over the years that cost is one of the best predictors of future success. And ETFs are a lot cheaper than mutual funds.

Bryan Armour

director of passive strategies research for North America at Morningstar

“As a fund holder in a mutual fund, you’re at the whims of other fund holders,” Armour said. “If they start selling, that might mean a taxable event for you.”

With ETFs, there’s no such similar taxable event, he noted.

“They’re much, much more tax-efficient than a mutual fund,” Armour said.

Of course, ETF investors will not be able to completely avoid taxes. They will have to pay taxes on their own capital gains. But because they get flexibility to choose that timing, they can hold off until they are eligible for the lower long-term rates.

‘It’s just an easier way to invest’

ETFs are a more efficient way of accessing a stock, bond or any other market asset class, according to Rosenbluth.

“You get the benefits of trading on an exchange; you get the benefits of diversification,” Rosenbluth said. “It’s just an easier way to invest.”

By investing in a fund rather than a single name stock, investors can hedge their risks.


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