To help determine whether mutual funds or exchange-traded funds are best for a client, Rydex Investments of Rockville, Md., has launched an online trading expense calculator.
The Rydex Trading Expense Calculator prompts advisers to enter factors such as number of trades, holding period, transaction or commission costs, annual expense ratio, share price and bid and ask spreads. The calculator, which can be used to compare any exchange-traded fund or mutual fund, provides an estimate of expenses.
Rydex developed the calculator because financial advisers want a way to compare the company's nine ETFs with the company's stable of 50 open-end mutual funds, explained Tim Meyer, Rydex's exchange-traded fund business manager. But the calculator, at www.rydexfundsfp.com, is not limited to Rydex products.
Both mutual funds and exchange-traded funds may share the advantages of low costs, diversification and tax-efficiency.
Plus, both investment vehicles pool money to invest in a mix of securities.
But one chief difference is that exchange-traded fund shares can trade during the day much like stocks, while mutual funds are priced once daily at the market close. Like stocks, exchange-traded funds also permit stop orders and limit orders to protect against losses, while mutual funds typically don't.
ETFs, launched in 1993, currently have more than $300 billion in assets. By contrast, mutual funds have more than $8 trillion.
"The adviser community wanted to analyze the impact of bid and ask spreads and trades during the day on ETFs and compare them to mutual funds," Meyer said. "Advisers want to dig deeper."
Typically, ETFs are more attractive for large investors, who can absorb greater risk and spread commission costs across sizable sums.
Also, the smaller expense ratios of exchange-traded funds today, according to some analysts, could work to an investor's advantage cost-wise over the long term in certain cases, regardless of trading commissions. For example, expenses for the Barclays iShares S&P 500 index exchange-traded fund run half the expenses of Vanguard's 500 Index mutual fund, which long has been hailed for record-low expenses.
But the advantage of exchange-traded funds-the ability to trade during the day-could also be one of their chief disadvantages because it can translate into greater investment volatility. "In fact, at any moment, the market price of an [exchange-traded fund] may be above or below the total market value of the securities it represents," according to a recent report by Vanguard Group of Valley Forge, Pa. Although the difference can often be quite small, it can become significant in volatile markets.
In some instances, there have been temporary gaps between the market value and trading price. That gap typically disappears. Nevertheless, an adviser's purchase price might be poorly timed and hit when there are price gaps. That can lead to buying at a price that's too high or selling too low.
Research by Weiss Ratings of Palm Beach Gardens, Fla., found that overtrading of ETFs is one of the biggest mistakes investors make. It also warns against over-allocating assets to the hottest exchange-traded funds.
"Although [exchange-traded funds] provide more diversification than individual stocks, most are narrowly specialized in one industry sector or region of the world," according to the Weiss report. "For proper diversification, investors should consider a broad range of [exchange-traded funds]."
There is no surefire answer whether it is best to invest in an ETF or an open end mutual fund. But the Rydex online calculator can help an adviser decide.
Advisers bringing new money into Rydex often are investing in ETFs as part of an asset allocation program, Meyer said. The advisers typically trade the EFTs three to four times annually to rebalance or to change portfolio weightings in relation to benchmark indexes.
"Our mutual funds are beta driven," he said. "We have funds with positive and negative betas. Advisers have questions about using our sector funds or ETFs or pure investment style plays with ETFs or mutual funds."
Tom Taggart, a managing director with Barclays Global Investors of San Francisco, said that any online calculator that lets investors compare ETFs to mutual funds should become a popular and useful tool.
Taggart said most financial advisers use Barclays' ETFs to improve the risk-adjusted rates of return on client portfolios. They invest in ETFs to track asset class performance. As a result, they can maintain a beta value of one on a portion of a portfolio. Next, they invest in actively managed mutual funds that are expected to deliver high alpha values. By combining the two investment vehicles, the adviser can get a high risk-adjusted rate of return on a portfolio.
"Anything that will help investors is a good thing," Taggart said. "Any tools out there will increase sales of ETFs."
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