Individuals who want to start investing in exchange-traded funds (ETFs) can transfer assets easily from underperforming assets to pursue heightened returns.
ETFs are often overlooked in favor of mutual funds, despite many advantages that ETFs have — lower expenses, fewer barriers to exit, simpler tax rules, etc. A couple of articles on stockinvestor.com provide basic information about key advantages of ETF investing.
Once investors are convinced to buy ETFs, many people still will wonder where to find the best funds. To find assets for buying ETFs, you should to ascertain which of your current investments are underperforming and transfer those funds into ETFs.
While your investments might perform well and provide robust returns, you still should consider transferring them into ETFs. Even if gross returns are similar, ETFs are generally less expensive to own, have less complex tax implications and are easier to trade.
Investment assets are generally in retirement accounts or in taxable investment accounts. You can convert either of these types into ETFs. Retirement accounts are not taxed right away. The tax is deferred until you retire and start making withdrawals. Non-retirement accounts incur taxable events every year and taxes must be paid accordingly.
These two types of accounts have considerably different rules regarding taxation. Therefore, it is important to keep them separate. You can transfer funds between retirement and non-retirement accounts under some circumstances. However, tax implications and complexity are usually not worth the effort.
Here are examples of assets that you could use to start investing in ETFs:
- Bank accounts, certificates of deposit (CDs), savings accounts, credit unions
- Mutual Funds
- Individual retirement accounts (IRAs): traditional IRAs, Roth IRAs, SEP IRAs, rollover IRAs, etc.
- 401(k) and other employer-sponsored retirement accounts
- Existing brokerage accounts with stocks or mutual funds
Individuals usually will own multiple types of accounts from the list above. Which of these accounts are best suited for investing in ETFs? Here are the top three suggestions.
1. 401(k) retirement accounts from former employers
Most individuals have savings and checking accounts. However, for many Americans, mortgages and 401(k) accounts are the only exposure to long-term investing. Billions of dollars are currently sitting in plans with past employers. Employer-sponsored retirement accounts, like the 401(k) accounts, usually have many rules and restrictions, as well as very few options to manage your investment. So, why not transfer those assets into an account that you can easily manage in hopes of yielding higher returns?
To avoid any tax liability, you must request a trustee-to-trustee transfer. In this transaction, the custodian of the retirement account will transfer the assets directly to the IRA custodian. If you have an IRA account at a brokerage firm or mutual fund company, you can roll it over into a brokerage account directly. You can even transfer assets without selling the shares, unless you are transferring mutual funds or company stock into a brokerage account. In that case, you will need to convert your 401(k) assets into cash before transferring that cash into your new or existing brokerage account while following specific transfer rules.
2. Mutual fund accounts
Investors have more than $15.7 trillion in mutual funds and only about $2 trillion in ETFs. Why should you transfer your assets from mutual funds to exchange-traded funds? ETFs are easier to trade, offer access to a wider variety of investment options and more. You can find seven reasons why ETFs are better than mutual funds in a previous article.
You can easily transfer some, or all, of your mutual funds’ assets into ETFs. Your mutual fund accounts can be transferred also into a different brokerage account, if that gives you access to a wider ETF selection or offers commission-free ETFs.
3. Bank savings accounts
Current interest rates are extremely low and savings accounts are earning very little interest. After you deduct inflation and taxes on the interest earned, your returns are minimal. So, why not make that money work for you in an ETF account. Indeed, savings accounts are FDIC insured against loss and ETFs carry risk like any investment. However, until savings interest rates become significantly higher than current rates, you can mitigate your risk with proper ETF investing strategies and you can take advantage of much higher returns with minimal risk
If investing in ETFs is something you are considering, just follow a few simple steps. Take inventory of all of your accounts, determine which are underperforming, decide which accounts to convert to ETFs and buy few exchange-traded funds.
If you are new to ETF investing, you will experience a learning curve. However, if you trade stocks and mutual funds, some of that knowledge and experience will transfer to ETF trading. Conversely, brokerage firms offer plenty of guidance and assistance if you have no ETF trading experience.
Check out additional articles on stockinvestor.com about different categories and types of exchange-traded funds, as well as few rules, terms and tips for investing in ETFs.
Doug Fabian is the editor of three publications: Successful ETF Investing, ETF Trader’s Edge, and Fabian’s Weekly ETF Report. Doug was previously known as one of America’s top mutual fund advisors, but in recent years he has made a revolutionary 100% shift to exchange traded funds (ETFs). He regularly appears at seminars around the country.