ETFs (Exchange Traded Funds) have become an increasingly popular means of investing in stocks. Today we consider this. Is there a best time to put your money into an ETF? But first, here is a little refresher about ETFs. Many investors have switched from mutual funds to ETFs. Investopedia explains the difference between exchange-traded funds and mutual funds.
ETFs trade throughout the trading day, like stocks, while mutual funds trade only at the end of the day at the net asset value (NAV) price. Most ETFs track a particular index and as a result have lower operating expenses than actively-invested mutual funds. Thus, ETFs may improve your rate of return on investments. In addition, ETFs have no investment minimums or sales loads, unlike traditional mutual funds, which often have both.
And there are tax benefits to ETFs versus mutual funds.
ETFs create and redeem shares with in-kind transactions that are not considered sales. Thus, taxable events are not triggered. Redemptions create tax events in mutual funds, but they do not create tax events in ETFs. When a forced sale of stock occurs, mutual funds record and distribute higher levels of capital gains than ETFs.
In addition, ETFs have greater tax efficiency due to a structure that allows them to substantially decrease or avoid capital gains distributions altogether. This difference can greatly affect the overall rate of return, even if an ETF and mutual fund both track the identical index.
Passive investors have found that, all too often, managed funds like mutual funds do not do as well as the overall market. Because ETFs are typically index funds, they track the market. So, ETFs may well be an ideal way to invest. But, is there a best time to put your money into an ETF? It turns out that there is!
Is There a Best Time to Put Your Money into an ETF: When Outflows Are High
Market Watch reports on a study by Deutsche Bank in an article about why it pays to be a stock market contrarian.
According to Deutsche Bank, not only can going against the current provide dramatically better gains over time than following the herd, but it also does notably better than a simple buy-and-hold plan.
The investment bank conducted a study examining how exchange-traded funds performed following periods of high inflows or outflows. While flow data can be messy – not only are they extremely volatile for the largest funds, but inflows can mean an investor is building a short position, which means he or she is betting the fund will decline in price – the results were dramatic. A portfolio that bought exchange-traded funds with substantial outflows saw significantly higher gains than one that moved with the herd – buying funds with heavy inflows.
This is a simple example of the investing maxim to buy low and sell high and is the basis of contrarian investing. It is also typically consistent with the use of intrinsic stock value analysis as a guide to investing instead of simply following the herd!
According to the Deutsche Bank study, an investor who always buys when inflows are highest will earn less than 50% of what someone earns who always buys when outflows are highest!