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I am considering to passively invest my savings, and I am deciding between an S&P 500 ETF or S&P 500 mutual fund. Yet, I am not sure what to look for in each option and how to calculate the costs related to each operation.

I would appreciate if you could point me out to the pros and cons for each investing approach, and how to derive the management costs related to each option.

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possible duplicate of What differentiates index funds and ETFs? –  JoeTaxpayer Jan 14 '13 at 4:54
    
@JoeTaxpayer. I saw that question. I would be interested to further delve in the expense ratio the selected answer is talking about. Is it fine to keep this question to further delve in the topic? or should I submit a comment for further explanation in the actual answer in the other post? Thanks –  Peretz Jan 14 '13 at 5:06
    
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Can you edit to clarify your question? What, specifically are you trying to understand that the other questions don't address? –  JoeTaxpayer Jan 14 '13 at 13:38
    
Please do clarify what about the question JoeTaxpayer linked doesn't answer for you. –  MrChrister Jan 25 '13 at 21:50

2 Answers 2

The procedure to compare the costs of a mutual fund and an ETF is to find two similar investment strategies and look at their prospectus. All the costs are listed online, and many sites have tools to compare not just funds in the same family but across multiple families. This is the same procedure that would be used to compare any two investment vehicles.

Other questions on this site discuss the general difference between and ETF and an index fund. Even if the average fund of type A is cheaper than the average fund of type B, you have to look at the actual funds that interest you to determine which is cheaper. The cost will vary from fund family to fund family.

The costs for two different funds with the same investing style is a function of the general fund costs of that family, and the specific costs of that fund.

Keep in mind that costs are only a part of the investment equation; along with investing style, strategy, tax treatment, risk...

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My suggestion would be to consider what kind of controls do you want over your holdings in the fund.

ETF advantages:

  1. Can be bought in limit orders which can be useful if you plan on trying to minimize some costs. Thus, instead of having the once a day pricing that an open-end fund has, an ETF is priced throughout the trading day and this difference could be exploited.

  2. Stop orders could be placed if you want to have an exit strategy. Some people may like the idea of having an automatic sell order if the price drops too much and this isn't possible with an open-end fund.

  3. Tax-efficiency. As the portfolios here change through a Creation/Redemption process, there is generally more tax-efficiency here though if a fund has a mix of open-end and ETF share classes this may not be completely true of only ETFs. At the same time, tax-managed mutual funds can be another option should one be more mindful of taxes than purely tracking an index.

Mutual fund advantages:

  1. Automatic investing can be simpler and less time consuming. Generally, you auto invest $x/month into an open-end fund and will have fractional shares that are handled easily. While Sharebuilder would be a way around this with an ETF, you also have to accept how Sharebuilder buys its shares that may or may not be acceptable. Open-end funds tend to be priced once a day and transactions are done on that amount.

  2. Dividend re-investment may be simpler here. If you have an on-line broker, there could be questions about how far into fractional shares do they account and how to handle the selling of those shares eventually. Open-end funds tend to be used to fractional shares and thus I'd see this as a perk here versus the ETF as I'm not sure if you could re-invest $20 into SPY to get whatever fractional share this would be.

  3. Lower transaction costs if you are doing regular purchases. If you plan to buy each month, a brokerage will likely have a fee to charge each time you buy that wouldn't be the case of an open-end mutual fund.

  4. No brokerage account needed. Open-end fund accounts can be opened directly with some fund companies which I had when I lived in the US.

The ETF vs. Open-End Index-Fund Shootout is a bit dated though possibly useful if one wants to consider the question of how well can various companies handle the idea of tracking an index if you want to look at things from the perspective of just how well do the managers do on their end of things.

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+1 - There's more to it than the headline question, and your overview of the things to consider is wiki-worthy. Nice answer. –  JoeTaxpayer Jul 13 '13 at 16:11

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