Why Do We Use ETF's?

Why Do We Use ETF's?

August 08, 2018

For those who have been with Aspire for over five years, you may have noticed a change in your portfolio from using primarily Mutual Funds to using more ETF investments in the portfolios.  You may have wondered why that is but have not asked before.

First off, let me explain what an ETF is. An ETF, or exchange-traded fund, is a marketable security that tracks an index, a commodity, bonds, or a basket of assets like an index fund. Unlike mutual funds, an ETF trades like a common stock on a stock exchange. Read More about ETF’s 

Over the last 10 years they have rapidly grown in their popularity. There are three key reasons why I have chosen to use these more in the portfolios.

  1. Cost – Compared to mutual funds, ETF’s generally carry a much lower internal cost. Over time, studies have shown that investments with lower costs tend to have higher long-term returns.  See Article 
  2. Lower Capital Gains Distribution – For those people with investments that are not in a tax-deferred account, there is nothing more annoying than the market losing money for the year but getting income distributions from your mutual funds where you owe taxes at the end of the year. Due to the trading structure of ETF’s, these capital gains distributions are dramatically less than they are with mutual funds, resulting in less tax surprises for you.
  3. ETF’s directly mirror a specific Index. (i.e., Large Cap, International, or Small Cap). In my opinion this is good from two perspectives. If I want exposure to the Large Cap Asset Class, and I know the ETF I am using mirrors the S&P 500 Index, I will get exactly the asset class exposure I want. On the other hand, a mutual fund often has more discretion in the investments they use which may skew the actual allocation I am trying to achieve. In addition, Mutual Funds tend to be over or under their benchmark each year. This often gets difficult to explain in a year when they are quite under. On the other hand, ETF performance exactly mirrors its underlying index (less costs). This makes comparisons to benchmarks easier to explain and understand.

While ETF’s have other positive characteristics, those above are the key reason I have added them to most of the portfolios. I hope these reasons illustrate the benefit they can provide for your portfolio.

This commentary was created by Aspire Planning Group and is for informational purposes only. The views expressed are based on current market conditions and are subject to change. There are no assurances that the techniques and strategies discussed herein are suitable for all investors or that the predicted results will occur. The commentary herein does not constitute investment advice, tax advice, or legal advice. Past performance is no guarantee of future results.