If you’re worried about outlasting your retirement savings, you’re not alone. More than two-thirds of U.S. adults think they will outlive their savings, according to Northwestern Mutual’s 2016 Planning & Progress Study. One in three (34 percent) say the likelihood of that happening is 51 percent or better, and 14 percent believe it’s a sure thing.
Something that can negatively impact the size of your nest egg—and how long it will last—are investing fees. FeeX, a free service that calculates fees in retirement and other investment accounts, estimates that investors lose up to one-third of their potential retirement savings to fees. Even a 1 percent difference in fees can translate to tens of thousands of dollars over time. Reducing fees is an easy way to make your savings last.
Mutual funds are popular investments, but they can have notoriously high fees that end up costing investors thousands of dollars (or more) each year. A lower-cost alternative may be exchange-traded funds (ETFs). Depending on your situation, it might make financial sense to make the switch.
ETFs are uniquely structured investment funds that track broad-based or sector indexes, commodities and baskets of assets. Most are passively managed funds that invest in the same securities as a given index. Even those that are actively managed generally have lower costs than mutual funds. Another perk: Many brokerage firms now offer commission-free ETF trading. Charles Schwab, for example, offers more than 200 commission-free ETFs from 16 leading providers.
Mutual funds are well known for their tax inefficiency. You’ll owe taxes on any capital gains if your mutual fund manager sells some of the winners in the portfolio—even if the fund lost money overall. This can happen every time some of the portfolio holdings are sold, which can be quite often considering that they are actively managed funds. In fact, many funds sell every stock or bond in the portfolio within a year.
ETFs offer much greater tax efficiency, mainly because they create fewer taxable events than most mutual funds. The majority of ETFs sell holdings only when the elements that make up the underlying index change. In addition, because of the way ETFs are created and redeemed, investors can postpone paying most capital gains until they sell the ETF. Keep in mind that ETFs that traffic directly in precious metals (e.g., gold, silver, platinum) are considered collectibles and taxed at a higher rate.
As with stocks, ETFs trade on regulated exchanges and can be bought and sold throughout the trading session. This provides a distinct advantage for ETF investors because they can buy and sell when they want and at a specified price level. By contrast, a mutual fund’s price (or its net asset value) is set once a day—after the market closes—so you have less control over timing and price when it comes to buying and selling.
Look at Returns
Of course, you shouldn’t buy an ETF just because it’s cheaper or get rid of a mutual fund just because it’s more expensive. It’s important to crunch the numbers and figure out what your return on investment will be with either vehicle, taking into consideration performance as well as all fees, transaction costs and taxes.
In general mutual funds are more expensive because of higher expense ratios (the ongoing annual costs), load fees (typically 2 to 5 percent of the investment), transaction costs and taxes on short-term capital gains. As passively managed funds, ETFs generally carry significantly lower expense ratios and fees and trigger far fewer taxable events.