Issue 2 • JULY 2007 





ETFs vs. Mutual Funds - Part 2

In last month's newsletter you were introduced to the basic's regarding mutual funds and ETF's. This month we explore the pro's and con's of each to see if there is a clear winner.

Without a long discussion on Passive or Active investment strategies here are some key points:

Investment Strategy: For a typical investment advisor trying to create "alpha" (outperformance) for a client the actively traded mutual fund would have the advantage here. Most ETF's are based on passive index strategies.

Liquidity/Tradeability: The ETF would win this category as they are traded like stocks intraday on the exchange. A mutual fund is only priced at the close of business each day so that is the only time when a buy or sell (redemption) can occur.

Tax Advantage: The ETF wins this category as well for taxable investment accounts. The actively managed mutual fund creates taxable gains and distributions inside the fund each year that are passed on to the shareholder. An ETF has little if any internal turnover which makes it a more efficient vehicle for taxable accounts.

Trading Costs: This advantage will go to the "No Transaction Fee" mutual fund. This advantage is generally for investors who dollar cost average into a portfolio each month. If you use NTF mutual funds there should not be commissions to get into them. The typical discount broker will charge a regular transaction commission for each ETF trade.

Both the ETF and Mutual Fund are tools that investors can use to complete the asset class category within their investment allocation. Is there a clear winner? Maybe for taxable accounts, otherwise they both can be used with confidence in your investing strategy.


What's an "option"
You may have heard the term "options" or "derivatives" the last time you turned on CNBC, but just what is an option?

An option is a tradeable vehicle much like a stock. In fact most all options correspond to an underlying stock. If an individual buys a "call" option he is buying the right to purchase a certain number of the corresponding shares of a particular stock. Why would someone do this? It is all about leverage. If someone wanted to own 1000 shares of Microsoft because they felt the stock price was going to go up in the very near future, they could spend $33,490 or they could buy an option to purchase Microsoft in July at a price of $33.. The option would carry a price based on the "time" value (that is the premium) and the actual intrinsic value (the amount the stock is trading above $33 per share). So essentially you could own the stock for a few thousand instead of $33,000. So what's the downside? Options expire on the 3rd Friday of their expiration month. So if Microsoft was trading at or below $33 on that Friday the option would be worthless.

Options have additional benefits to. Next month we will discuss Covered Call strategies to generate income.

Financial Tips
2007 Contribution Limits:

401k contribution limit is $15,500 and the over age 50 catchup is $5000.

Roth IRA contribution eligibility phaseout is $156,000 to $166,000 AGI for Married Filing Jointly.

Roth IRA contribution eligibility phaseout is $99,000 to $114,000 AGI for single filers.

Roth contribution limit for 2007 is $4000 with over age 50 catchup of $1000.



James A. Daniel,
CFP®, AIF®

This newsletter if for informational purposes only. The information contained within should not be considered as financial advice nor soliciation for financial services. Consult with your financial professional if you have any questions.

The Advisory Firm, LLC is a fee-only financial planning company and registered investment advisor.


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