Why Are ETFs So Popular?

An exchange-traded fund is similar to a mutual fund in that most offer portfolios of hundreds of different securities. However, an ETF, as the name suggests, is bought and sold on a stock exchange, rather than directly from a mutual fund company. One of the most popular ETFs is the SPDR S&P 500 ETF, which tracks the S&P 500 index and trades an impressive 74 million shares per day on average. What makes ETFs so popular? Read on and find out what investors like most about exchange-traded funds.

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All Shapes and Sizes

The ETF industry has absolutely exploded from its founding in the 1990s. In just 30 years, assets in the global ETF industry have mushroomed from zero to $9 trillion as of August 2021. Within those $9 trillion in assets are an extraordinary variety of ETF choices, part of the reason they are so popular with investors. There were more than 7,600 distinct ETF options for investors as of 2020, covering all major asset classes, sizes and styles. In addition to broad-based index funds, you can buy an ETF with a focus on everything from Africa to biofuels to the Swiss franc. In other words, if you’re looking to buy something as an investor, there’s likely an ETF that covers it.

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Low Cost

Exchange-traded funds typically have low annual expenses, an edge they have long held over their traditional mutual fund peers. Part of the reason is that most ETF portfolios are passive, meaning they track indexes or target markets without much interference from fund managers. But still, the fee advantage can be sizable. According to Morningstar, although traditional mutual fund fees have been falling dramatically, they still averaged 1.04% annually for actively managed funds as of 2020. Most ETFs have much lower expenses. For example, the popular SPDR S&P 500 ETF has an annual expense ratio of just 0.0945%.

Since ETFs are traded on a stock exchange, you can typically buy or sell them with $0 commission as well, as most major firms now offer commission-free stock and ETF trading online. Although many mutual funds are no-load, a large number still charge commissions.

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Tax Efficiency

Exchange-traded funds typically don’t make taxable year-end distributions, as many traditional mutual funds do. This is because most ETFs track an index and don’t have as much turnover. Rather than being subject to taxable distributions that are beyond your control, with an ETF you will only owe taxes based on the profits and losses of your individual trades.

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Traders often prefer ETFs over traditional mutual funds simply due to their liquidity. As an ETF trades on an exchange, you can buy or sell one at any time the market is open, even multiple times in a single day. With a traditional mutual fund, you can only buy or sell once per day, after the market closes. In a fast-moving market, you could find yourself burned not being able to get into or out of your mutual fund position if you’re holding a traditional mutual fund.

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Low Minimum Investment Requirements

Many mutual funds have investment minimums of $1,000, $2,000 or even more, but this just isn’t true with ETFs. If you’re working with a broker that offers fractional shares, you can buy as little as $1 of an ETF if you so desire. Otherwise, your investment minimum will simply be the amount needed to buy a single share of the ETF. This can make ETFs a great choice for beginning investors or those without a large sum of money to begin investing.

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Last updated: Sept. 8, 2021

This article originally appeared on Why Are ETFs So Popular?