The Pros of Exchange-Traded Funds

Exchange-traded funds have several advantages over mutual funds.

ETFs offer more flexibility

ETFs trade throughout the day on the exchange, so you can buy and sell them when you want. When you buy a mutual fund, in contrast, you’re buying at the end-of-day net asset value, no matter what time of day you place your order.

The annual expenses of ETFs may be lower than those of mutual funds

If you are considering an index mutual fund, it’s worth investigating to see if an ETF follows the same index. The ETF’s expense ratio could be cheaper.

You can buy and sell ETFs throughout the trading day.
Most ETF trading takes place between shareholders on the exchange—ETF sponsors do not need to sell stocks to meet redemptions.

Because of their structure, ETFs should be more tax-friendly than mutual funds

With a mutual fund, investor selling can force managers to sell stocks in order to meet redemptions, which can result in taxable capital-gains distributions being paid to shareholders. In contrast, most trading in ETFs takes place between shareholders, shielding the fund from any need to sell stocks to meet redemptions. Furthermore, redemptions made by large investors are paid in-kind, again protecting shareholders from taxable events.

All of this should make ETFs more tax-efficient than most mutual funds, and they may therefore hold a special attraction for investors in taxable accounts. Keep in mind, however, that ETFs can and do make capital-gains distributions, as they must still buy and sell stocks to adjust for changes to their underlying indexes.