Why Average Investors Prefer Mutual Funds over ETF’s

Many articles have been written on the pros and cons of both mutual funds and Electronically Traded Funds, or ETF’s. Both methods of investing are simply a group of particular securities (stocks, bonds, commodities, etc.) bundled into one investment product and reflecting one price of all the underlying securities.

Mutual Funds vs. ETF’s

The major differences between the two concepts:

  • ETF’s trade on the market exchanges, such as the NYSE, similar to any other stock. Mutual funds trade once per day at the 4:00pm EST closing price. Thus, ETF’s are more liquid than mutual funds.
  • Mutual funds can have various ways of charging fees, such as annual expenses, front end sales loads, back end redemption loads, early withdrawal fees, etc. ETF’s charge a set expense ratio.
  • ETF’s have lower holding costs than mutual funds, but since they trade like stocks, an ETF causes a trading commission every time an investor wishes to add to his portfolio.
  • Mutual funds provide for reinvestment of dividends. Under an ETF, the investor would have to purchase additional shares with the dividend and pay additional commissions.

What the Average Investor Wants in a Fund

The discussion of which investment product is better mainly depends upon the level of knowledge and the degree of involvement of the investor. Most novice investors in the securities markets are there because they have been encouraged to do so. They get bombarded by their employer with memos on their 401k, or by their IRA providers telling them to get their assets out of money market funds and into the markets for the long term. The problem is these novice investors do not even know how to start researching various funds, nor do they want to be involved very much in the decisions. What these investors want and need is one set of funds from which to select their long term investments, and someone to help explain the choices.  After this has been accomplished, they want to be able to call someone with any problems or questions.

Looking at mutual funds vs. ETF’s from the above viewpoint, the investor has 3 avenues to explore:

  • Open a brokerage account and buy ETF’s – the problem with simple brokerage accounts to the novice investor is that they do not get advice. Brokers merely process trades.
  • Hire an investment manager – this is a higher level of service account offered by most brokerages. Under this approach, the novice investor will not have to do anything but complete the initial paperwork. The primary problem is which manager to select and lack of understanding about how the manager will invest the assets. There is also the issue of trust given the Bernie Madoff’s in the financial world.
  • Select a mutual fund family for all investments – picking one large company that has many different types and sizes of mutual fund offerings.

The best approach for the novice investor is to place all assets with one large, well known mutual fund company.

Dealing with One Mutual Fund Family

Each of the large mutual fund families such as Fidelity, T. Rowe Price, Scudder, Vanguard cater to the average investor. They each have many large funds covering all the major asset classes such as stocks, bonds, real estate, commodities, money markets, etc. Investors looking for help in how to invest can have long discussions with the customer service representatives about the various fund choices. These Reps will only give general descriptions and will not make actual recommendations. They will help the investor narrow down the choices by constantly asking the investor questions about goals and risk tolerance. This is really what these investors are looking for – someone to talk to who is unbiased and a company that can be trusted to handle a person’s money. The companies know that investors are driven by customer service and any drop in the quality of service will soon have many investors going elsewhere with their assets.