Much like a thoughtful gift, quality investment tools come in packages of all shapes and sizes. Two well-known investment packages are mutual funds and exchange-traded funds (ETFs), which might look the same from the wrapping, but have significant differences once we peek inside.
Mutual funds have been around since 1924 while ETFs are a relatively newer addition to the markets, having landed on the scene in 1993. Mutual funds outnumber ETFs, but the number of mutual funds has been declining for several years while ETFs have been increasing since their inception.
Both types of funds are designed to package groups of assets toward an overall investment goal. Both can invest in stocks, bonds, and other types of securities. The similarities more or less end there.
First, ETFs are (usually) more tax-efficient than mutual funds. Mutual funds pool money from investors to purchase stocks, bonds, and other securities. Therefore, every time a shareholder adds new money to a mutual fund or redeems their shares, the underlying securities must be bought or sold, respectively. Taxable events in the form of capital gains accumulate throughout the year and all investors incur the cost, regardless of fund performance.
ETFs, on the other hand, minimize taxable events by exchanging ETF shares and underlying securities “in-kind” whenever possible, making capital gains distributions less likely. An ETF investor’s capital gains are not influenced by other investors entering and exiting the fund.
ETFs also tend to have lower fees than mutual funds because ETFs are typically passively managed while mutual funds are actively managed. However, fees may vary as some ETFs, like most of those offered by TrueMark Investments, are actively managed by experienced portfolio managers. ETFs may also incur additional costs associated with buying and selling, such as brokerage commissions. Brokerage commissions and other ETF expense reduce overall return.
Here are some other key differences between ETFs and mutual funds:
- ETFs can be bought and sold whenever the market is open. Mutual funds can only be bought and sold at the end of the trading day.
- Most ETFs publish their holdings daily, offering more transparency than a mutual fund.
- Unlike mutual funds, ETFs are listed on an exchange and are traded like a stock.
- ETFs buy and sell the holdings in their package less often than a mutual fund.
- Mutual funds tend to have higher minimum investment requirements than ETFs. The minimum investment requirement for a mutual fund is often a flat amount whereas the minimum investment requirement for an ETF is typically the price of one share.
- ETF shares can be bought and sold on the open market between investors. Mutual fund shares can only be traded with the fund provider.
In summary, investors tend to choose ETFs over mutual funds for their tax efficiency, lower fees, flexibility, and transparency. While every fund is its own unique package, the best way to pick the right one is to take a peek inside.
Source: www.investopedia.com/articles/exchangetradedfunds/08/etf-mutual-fund-difference.asp
