ETF Gains Favor Over Mutual Fund

Investors kept pumping more money into U.S. mutual funds and exchange-traded funds (ETFs) in December 2008, finishing the year with a flourish. Behind the industry expansion, stock mutual funds suffered record net outflows.

Exchange-traded funds attracted nearly $178.4 billion in net inflows for the year. That was a record, some 20% more than the previous high, which was set in 2007. The latest National Stock Exchange data estimated that in last year's final month, ETFs had a record $42.8 billion net inflow.

U.S. mutual funds saw net inflows of $503.2 billion in 2008, the research firm Lipper Inc said. But stock funds saw net outflows of $176.7 billion for the whole of 2008, it said. The net inflow to U.S. mutual funds was chiefly contributed by net $658.2 billion money-market funds as investors took shelter in the relatively safe instruments on concerns about volatile stock and bond markets.

ETFs gain investors favor

The 2008 data shows that while the ETFs flourished, the stock mutual funds experienced huge exodus. The data signifies ETFs is gaining investor favor over traditional mutual funds. Many financial advisers and investors use indexed ETFs as part of a conservative asset-allocation plan. In general, they have a long-term perspective and haven't been selling during the market downturn.

Exchange Traded Fund, also known as ETF, is a fund that tracks an index, but can be traded like a stock. ETFs always bundle together the securities that are in an index.

There are more than 800 ETFs listed in the U.S. The industry's assets continue to be highly concentrated in a handful of managers. A trio of firms, Barclays Global Investors, State Street Global Advisors and Vanguard, control about 85% of all U.S.-listed ETF assets, according to consultants Financial Research Corp.

The benefits of ETFs for investors are compelling; therefore investors should consider them for significant portions of their portfolios, without necessarily eliminating traditional mutual funds entirely.

Exchange Traded Fund, also known as ETF, is a fund that tracks an index, but can be traded like a stock. ETFs always bundle together the securities that are in an index

ETF benefits over traditional mutual funds

Investors can purchase ETFs that mimic ever-narrower slices of the market, such as a single sector of the Morningstar style grid or a particular industry. This focus gives investors greater precision and more flexibility in executing their investment process.

ETFs provide investment vehicles for investors who select sectors of the market that offer exceptional investment potential as their investment strategy. When active managers' out performance comes from sector-level decisions, instead of stock selection within sectors, the performance differential to more narrowly defined benchmarks was minimal in most cases and often in favor of the indices.

The ability to buy and sell ETFs on an exchange like stocks gives investors the potential to take advantage of stock market movements that occur in short period of time. You don't have to worry about short-term redemption penalties, often around 2% for mutual funds.

An ETF won't close to new investors because its asset base gets too big.

ETF disadvantages over traditional mutual funds

ETFs are generally not cost-efficient for investors using dollar cost averaging, especially if they are investing small amounts. Transaction fees will often mitigate the benefits of lower fund expenses. In these situations, no-load, no-transaction fee funds are often a better solution.

Investors who regularly pull money out of their funds for income face the same problem. These individuals would be better off to either use a no-transaction fee fund for the withdrawals or make larger but less frequent withdrawals from an ETF.