July 5, 2012

Top 10 Investor Errors: Mutual Fund vs ETFs

Sixth of 10 articles by Barry Ritholtz.

Think of ETFs as mutual funds that trade on a stock exchange, through a broker. Regular mutual funds are only available through their parent company or registered investment advisors, all of whom take a fee for managing, handling or promoting them. ETFs have few such fees.

There are two sides to this argument, however. Remember that any broker will charge a commission on shares bought and sold, including ETF shares. If you're planning on buying ETF shares monthly as part of an IRA investment plan, expect to pay commission on each purchase. That can add up to a higher percentage of your annual investment sum than simply paying management fees on a regular mutual fund.

A $10 commission on a $416.66 monthly investment ($416.66 x 12 = $5000 maximum annual IRA contribution) amounts to 2.4%. Do that every month and the investment is robbed of 2.4% before it buys any shares.

Compare that to any mutual fund with annual management fees under 1%, considered the threshold of "reasonable," or any of the more aggressively managed funds, where fees often run well over 1%.

ETFs work best if you plan to make one or two large purchases per year, rather than several smaller buys.