Active mutual funds are called that because a fund manager is "actively" trading securities, usually with the intention of beating the market you’re invested in, be it global stocks, U.S. technology, emerging market debt, etc. And you typically pay more for that service. The average mutual fund charges over 1% in fees2, also known as the expense ratio. It doesn't sound like much as a percentage, but that's more than $1,000 each year for every $100,000 you have invested.
ETFs, on the other hand, generally aim to track market indexes, so typically there is much less trading going on. While experts still manage the portfolios, the fund expenses tend to be a lot lower. iShares Core funds are about one-tenth the cost of a typical mutual fund, according to Morningstar.3
iShares ETFs may also save you money come tax season.
When another investor in a mutual fund wants to cash out, the fund manager may have to sell securities to meet that request. That can result in a distribution back to you, which would be subject to capital gains taxes. This cost may be significant if you’re not investing within a tax-deferred retirement account. With ETFs, however, investors buy and sell shares on an exchange, which insulates them from the effect of other shareholder transactions.
Additionally, just as portfolio turnover means higher management expenses, it can also mean higher capital gains distributions as holdings move in and out of the fund. ETFs tend to trade less within the portfolio, so this effect is reduced. Over the past five years, 97% of iShares funds have not paid any such capital gains distributions.4 Of course, investors' own ETF trading will generate tax consequences and transaction expenses. For more information on the differences between active mutual funds and ETFs, click here.
Even though you pay more for an active mutual fund to potentially outperform the markets, they don't always do so. And over the long term, the lower costs of iShares ETFs could mean a lot to your bottom line.
So if you're ready to break out of the "pay for performance" paradigm, consider iShares Core ETFs to build the foundation of your portfolio.