‘Flash Crash’ Shows How Mutual Funds and ETFs Differ

The market’s sudden drop on May 6 was stunning for investors to watch. While it had a far-reaching effect, it primarily has thrust exchange traded funds (ETFs) into the spotlight. But is that fair? Chuck Jaffe for MarketWatch reports that the meltdown only highlighted the differences between ETFs and mutual funds, showing why some investors may choose one or the other:

• ETFs are mutual funds that trade like stocks. They are priced minute-by-minute throughout the day; if you want in or out, you should get the market price the moment you pull the trigger. Some brokerages are taking expenses down to 0, helping investors that want to make the trade.With mutual funds, all transactions are made at the next closing price. [Comparing the Costs of Both Funds.]
• ETFs, typically, are focused on indexing — although there are more actively managed offerings all the time — while traditional funds focus more on active management. [Taking the Best of Both Worlds.]

Vanguard Group founder and index investing legend Jack Bogle has long said that ETF investors tend to trade at the wrong time instead of buying and holding in order to capitalize on the broader trend, and his words are once again being brought to the fore.
With all due respect to Bogle and others who are critical of ETFs in the wake of the crash, we disagree.

• First, to suggest that mutual fund investors are better served because they offer end-of-day pricing is mind-boggling. Without even getting into that argument, the benefits that ETFs offer over mutual funds still make them far more appealing and better for investors. You can’t beat their transparency, low-cost, tax efficiency and ease of use. On top of that, intraday liquidity is a superior feature that makes ETFs leaps and bounds better than mutual funds. Why wait until the end of the day to do what you want to do now?
• Second, Bogle is assuming that most investors don’t have the mental capacity to handle ETFs, but that is simply not true. Pointing fingers at ETFs and their users is just silly. Just because  there are some bad drivers on the road does not mean that all drivers need to be painted with the same broad and insulting brush.