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Introduction
There is a variety of positions for mutual funds, index funds, and ETFs can be compared between one another. The first point of comparison is the capacity to be bought and sold at will. For Index Funds and ETFs, real time trading and pricing throughout the market hours is fully available (Ben-David et al. 2016). Mutual funds, on the other hand, cannot benefit from such an option. In terms of sales charges, Index funds and ETFs typically do not feature any, aside from various brokerage commissions if such services have been used (Elton et al. 2019). Mutual funds, depending on the conditions of negotiation when opening them, may have sales loads as well as purchase and redemption fees.
When it comes to minimum investment, there are none for exchange-traded funds, as the investor can buy a single share. Index funds’ minimum investment varies between 0 and 3,000 dollars, depending on who is offering (Dannhauser 2017). Typical investments in mutual funds are high, which explains their attractiveness to large companies rather than individual investors.
Expense ratios for ETFs and Index funds are typically low, varying between 1.5%-2%. It is not the same for mutual funds, however, as expense ratios in those differ based on the management style (Elton et al. 2019). In regards to liquidity, ETFs are traded like normal stocks and can be used intra-day. At the same time, Index funds and mutual funds are traded at the end of the day, because of a system called Net Asset Value, which sets the price per share of a portfolio (Stowell 2014).
Its value is calculated when the trading day is about to close. The choice of fund dictates the consequences of purchases and sales. ETFs, when selling shares on the secondary market, typically do not affect security prices. They also do not impact tax efficiency and do not trigger capital gains and losses on the underlying securities. Purchasing a large number of shares using a mutual fund, or redeeming them, however, could cause a variety of issues (Stowell 2014). For example, it can affect the underlying security prices during purchasing or selling of shares. It can affect the fund’s NAV and returns, trigger capital gains or losses, and affect tax efficiency (Stowell 2014).
ETFs, due to their nature, are more transparent than mutual funds, having to report their holdings on a daily basis. Their counterparts, on the other hand, only need to do so on a quarterly basis, making them less obvious. In additions, ETFs fully invest their money into stocks, whereas mutual funds have to keep at least 5% of their assets in cash, so that they would have money to pay for daily redemptions (Stowell 2014).
Finally, ETF features returns as per with the market index, whereas mutual and index funds do not. ETF and Index allow for arbitrage between futures and the cash market, whereas the mutual fund does not. The former two are also generally more ubiquitous in trading and managing, as they allow for paperless investing. At last, neither of them features any exit loads. Mutual fund cannot be closed prematurely without the investor taking a hit. As it is possible to see, all three of these offer different options and benefits to their users, thus geared towards achieving different objectives.
Comparison of Risks
ETFs are associated with various risks that could occur, many of which are outside of the investor’s control. The biggest risk is that associated with the market. If the markets go down and the ETF’s stocks go down as well, the investor suffers losses. The second biggest risk comes from the multitude of choices and the inability to project further developments. Differentiation and planning for future benefits is difficult because of the lack of understanding and too many choices. Additional issues include tax risks, exposure risks, as well as counterparty, shutdown, and force majeure risks. Some of these are demonstrated by the existing Coronavirus crisis.
In index funds, the primary risks are three: lack of flexibility, underperformance, and tracking errors. Index funds have less flexibility when compared to ETFs, and cannot react to price declines as quickly and efficiently. According to Rick and Kahan (2018, p. 32), “An index fund may not perfectly track its index. A fund may only invest in a sampling of the securities in the market index, in which case the fund’s performance may be less likely to match the index.”. Finally, fees and expenses, trading costs, and tracking errors may force the index fund to underperform (Rick and Kahan 2018).
Mutual funds face market risks, inflation, interest rate, currency, and credit risks. The former, much like with ETFs and Index Funds, stand for the possibility of partial or complete loss of one’s investment as a result of a market shift. Inflation risks endanger the fund’s purchasing power – if its increases are less than inflation rates, then the fund suffers (Hornstein and Hounsell 2016). High interest rates and low bond prices constitute interest rate risks. Currency risks arise from the need to exchange one currency into another to operate. Poor exchange rates are dangerous to all funds (Elton et al. 2019). Finally, if the issuer of a stock or a bond does not have enough money to make interest payments or offer redemption, that constitutes a credit risk for the company.
Scrutiny of Investment Companies’ Products
Investment companies stand for organizations that operate in the business of investing the combined capital of many investors into various financial securities with the purpose of extracting profits from their growth. The investors relegate the authority to use their money and buy/sell securities to such companies. Typically, the products offered by investment organizations are as follows (Stowell 2014):
- Stocks. Investing ins tocks allows for equity ownership in publicly-traded companies. As companies offer stocks to raise operational funds, they promise benefits to those who purchase stocks over a long period of time. The company analyzes stock investments based on long-term and short-term capacity to pay, as well as future earnings and price-to-earnings ratios. Stocks may offer various sorts of dividends in order to increase the income payout component.
- Bonds. These products are offered for providing fixed income. Governments and large corporations typically issue bonds. Companies may offer bond products to their customers, should said customer wish to be secure in their investment, as governments constitute some of the most reliable investees. Bonds pay investors in coupon payments, followed by a major repayment when the bond matures.
- Derivatives. These constitute a plethora of investment products offered by companies to purchasers based on underlying asset movements. Normally, they allow for a greater degree of control over stocks and futures, such as put or call options. Additionally, companies customize investment products in order to reduce risks, speculate on price movements, and others. Successfully utilizing derivatives requires users to have a degree of market knowledge and experience.
Reference List
Ben-David, I., Franzoni, F. and Moussawi, R. (2016) ‘Exchange Traded Funds (ETFs)’, National Bureau of Economic Research, 9, pp. 169–189.
Dannhauser, C.D. (2017) ‘The impact of innovation: evidence from corporate bond exchange-traded funds (ETFs)’, Journal of Financial Economics, 125(3), pp. 537–560.
Elton, E.J., Gruber, M.J. and de Souza, A. (2019) ‘Passive mutual funds and ETFs: performance and comparison’, Journal of Banking & Finance, 106, pp. 265–275.
Hornstein, A.S. and Hounsell, J. (2016) ‘Managerial investment in mutual funds: determinants and performance implications’, Journal of Economics and Business, 87, pp. 18–34. Web.
Rock, E.B. and Kahan, M. (2018) ‘Index funds and corporate governance: let shareholders be shareholders’, SSRN Electronic Journal, 18(39), pp. 1–61.
Stowell, D.P. (2014) Investment banks, hedge funds, and private equity. 3rd edn. Waltham: Academic Press.
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