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Which Works Best: ETFs or Mutual Funds

Are you better off owing conventional mutual funds or exchange-traded-funds (ETFs) focusing on the same sector? I’ll tell you what you need to know, but leave the decision up to you.

ETF Advantages
Both mutual funds and ETFs track the returns of stocks or other securities in specified market sectors. But ETFs offer trading advantages. Unlike mutual funds, you can buy and sell ETFs just like stocks, and you pay the same commissions as you would for trading stocks. Most ETFs require no minimum investment, and there is no required holding period. ETFs can be traded at any time during the day, but mutual funds trade only once a day, after the market closes.

Mutual Fund Advantages
Although ETFs may be easier to trade, you’d think that mutual funds would generate better returns. Most are actively managed by professionals who can react to changing market conditions. By contrast, most ETFs either track fixed indexes, or indexes that can only be changed quarterly.

What the Numbers Say
With that in mind, let’s see what the numbers show. We’ll start with China and India, which were last year’s hottest markets.

In China, an ETF, PowerShares China (CHNA), racked up a 66% return, edging out managed mutual fund Matthews India Investor (MINDX), which returned 64%.

Looking at India, two ETFs,  iShares MSCI India Small-Cap (ticker SMIN), up 53%, and EGShares India Small-Cap (SCIN), up 47%, beat the best mutual fund, Wasatch Emerging India (WAINX), which returned 45%.

In the U.S. biotechnology was the strongest category in 2014. There, First Trust Arca Biotech (FBT), an ETF, gained 48% compared to 35% for the top mutual fund, Fidelity Select Biotechnology (FBIOX).

Real estate investment trusts (REITs), a type of corporation limited to investing in commercial real estate, was another strong category last year. The top ETF focusing on REITs, iShares Residential Real Estate (REZ), returned 35%, compared to 32% for the best mutual fund, Phocas Real Estate (PHREX).

Three Year Returns
Obviously, last year’s numbers aren’t necessarily typical of long-term performance. Looking at three-year returns generally told a similar story, but the differences narrowed.

For instance, the top performing ETFs, Market Vectors Biotech (BBH), up 45%, and First Trust Arca Biotech (FBT), up 44%, narrowly beat the top funds, Fidelity Select Biotechnology (FBIOX), up 44% and Rydex Biotechnology (RYOAX), up 39%, on average, annually.

After biotechs, pharmaceutical makers were the strongest category over the past three years. There, a mutual fund, T. Rowe Price Health Sciences (PRHSX), up 37%, edged out the top ETF, PowerShares Dynamic Pharmaceuticals (PJP), which returned 36%.

Transportation stocks, e.g. railroads and airlines, also outperformed over the past three years. Looking at that sector, the SPDR S&P Transportation ETF (XTN), up 29%, outperformed the best mutual fund, Fidelity Select Transportation (FSRFX), which gained 26%.

There you have the numbers. Draw your own conclusions.

For these comparisons, I considered only no-load mutual funds currently open to individual investors and unleveraged ETFs, meaning that they do not attempt to double or triple their sector’s returns.  

published 1/23/15

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