One question that often comes up when deciding on how to invest is the choice of investment vehicles. If you want to buy low cost investments then index funds and exchange traded funds (ETFs) are the best choices.
Most investors are better off with index funds for a number of reasons – however it really depends on the individual situation. Let’s take a look at some of the differences between these two investment types first.
Exchange Traded Funds – ETFs
- Lower ongoing management costs (MER).
- Higher trading fees.
- Manual orders (ie you have to sign in and order each purchase).
- Higher MERs.
- No trading fees.
- Orders can be automated.
Since most investors tend to make purchases on a regular basis, the trading fees on an etf will quickly eliminate any advantage of the lower MER. This means that index funds are often a cheaper alternative.
Another factor is the size of portfolio – if the portfolio is large enough then ETFs might make more sense. The MER savings on a larger portfolio might outweigh the higher trading costs.
Keep in mind that not all ETFs are cheaper than index funds and trading and annual account fees can vary quite a bit between institutions.
Most smaller investors (less than $100k) are likely better off with index funds because of the lower trading fees.
Larger investors have more choice – they can keep going with index funds, or switch to ETFs or perhaps own both.
Once you have a large enough portfolio, you can consider having the bulk of your portfolio in ETFs and then make regular contributions into index funds. This way you get the low MERs of ETFs and have cheap trades with index funds.
I recommend signing up for a free Morningstar membership, which will allow you to research more about ETFS and index funds.
Thanks to Green Panda Treehouse (a personal finance blog) for this post suggestion.