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Index Mutual Funds or Exchange-Traded Funds? How About Both!
By JLP | November 1, 2007
Yesterday’s Getting Going column, Spicy or Mild? When ETFs Are Better Than Index Funds (free), in the Wall Street Journal took a look at investing in index mutual funds vs. exchange-traded funds. Jonathan recommends using both:
Use index mutual funds for accounts you’re regularly adding to or drawing on, while stashing longer-term money in exchange-traded index funds. That combo should trim your investment costs — and further boost your fund returns.
This idea has merit because exchange-traded funds typically have lower management expenses than mutual funds. The only problem is that exchange-traded funds trade like stocks, which means there are transaction expenses. Of course there are ways to reduce transaction charges by using a low-cost broker like Scottrade. Scottrade charges $7 per trade but will only trade full shares. Another route you could go is to open a basic account with FOLIOfn, which run $199 per year but gives you 200 trades per month on a select list of companies. On a small account $199 per year is pretty steep but gets more reasonable as the size of the account increases.
Account size also weighs in with mutual funds as most mutual fund companies have account minimums. One way around this is to set up an account and do monthly direct deposits into the account. Then as the account grows more options will open up to you.
One thing I have always liked about ETFs is their simplicity and the ability to set up portfolios the way I want them set up. For instance, I like the ability to break down the Dow Jones Total Market Index into ten sectors and invest an equal amount in each sector. I can do this with iShares ETFs but not with mutual funds.
Anyway, it is something to think about. I like to look at index mutual funds and exchange-traded funds as tools. One tool may work perfect for one job but be totally useless for another job. It’s better to have a tool box full of tools.
Topics: Exchange-Traded Funds, Getting Going, Investing, Jonathan Clements | 3 Comments »
November 1st, 2007 at 11:56 am
There are now offers form BofA, Wells Fargo on certain type of accounts (Wells Fargo calls it Portfolio Management Account) that allow you to buy ETF’s without any transaction fees. I know for sure about Wells Fargo, which allows you to do 100 free trades per year (~8 per month) which I find more than adequate to meet my needs.
Only thing I am not sure is the speed of execution, or if broker, might do the trades differently, to the advantage of the buyer, if it was all paid . But I believe this will always be a question.
On a related note, my ETFs are in taxable account. Am I better of NOT reinvesting my dividends so that I can avoid complex gain/loss calculations, so that at the year end pay tax on a fixes dividend amount.
What’s the minimum detail do I need to maintain should I opt for dividend reinvestment. Any pointers on this topic will be great.
November 1st, 2007 at 12:06 pm
I think the quote you used provides a good guideline. I wouldn’t want to keep paying the trading fee each month when buying funds (unless I had paid for the account with free trades). But ETFs do look like an good tool–as long as one is commission-savvy, etc.
November 6th, 2007 at 11:02 pm
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