When it comes to funds, many people are confused about the differences between mutual funds and Exchange-Traded Funds (ETFs), which share a similar name but contain a few key differences. In this guide, we aim at differentiating the two investment vehicles by looking at some of the common questions that people have when investing in mutual funds and ETFs. We will first define what these funds mean before moving onto comparing them. Finally, we will provide guidance on how you can choose a broker that works best for you should you want to participate in investing.
What are mutual funds?
Mutual funds are investment vehicles that pool money from different investors to purchase a diversified portfolio of stocks, bonds, and other securities. A mutual fund is managed by a fund manager, who makes investment decisions and maintains the portfolio of securities on behalf of the investors.
Some examples of mutual funds include the Vanguard 500 Index Fund, which invests in a diversified portfolio of large-cap US stocks with the goal of replicating the performance of the S&P 500 index, and the Fidelity Contrafund, which invests in a mix of large- and mid-cap US stocks with the goal of generating long-term capital appreciation.
What are ETFs?
ETF stands for Exchange-Traded Fund. An ETF is a basket of securities that share a characteristic, such as their origin, asset class, sector, or management style, and it tracks the performance of these securities. As its name suggests, traders trade ETFs like stock on exchanges.
Some examples of ETFs that are popular around the world include Invesco QQQ ETF, tracking the performance of the NASDAQ-100 index, which is composed of the largest non-financial companies listed on the NASDAQ stock exchange. The Vanguard Total Stock Market ETF tracks the performance of the CRSP US Total Market Index, which includes stocks of all sizes from the entire US stock market. The iShares MSCI EAFE ETF tracks the performance of the MSCI EAFE index, which is comprised of stocks from developed markets outside of North America, including Europe, Asia, and Australia.
Similarities between mutual funds and ETFs
Both mutual funds and ETFs are investment vehicles that pool money from different investors to purchase a diversified portfolio of securities. Not only that, but they share a lot of similarities. Below, we go through the main ones.
Used for portfolio diversification
Both funds are great for portfolio diversification due to the large expanse of securities and assets they cover. These funds provide investors with the opportunity to invest in a diverse portfolio without having to have many positions open individually. They also provide access to companies and securities investors may normally have difficulty purchasing individually.
Both types of funds are popular among investors around the world, and they tend to be highly liquid investments. Investors have traditionally been able to buy and sell shares relatively quickly and easily, and they are able to enter and exit the market smoothly.
Both mutual funds and ETFs follow strict regulations local to the country of issue, maintaining high security for investors. They must comply with certain rules and laws designated to protect investors, making them less risky than other types of products.
Finally, mutual funds and ETFs cover a wide variety of asset classes in their pooled investment, ranging from stocks and bonds to real estate. This makes them flexible investments and brings investors back to the first point – of being great for portfolio diversification.
Differences between mutual funds and ETFs
Nevertheless, mutual funds and ETFs are not the same, and below are some key differences that investors should take into consideration before investing in one.
Mutual funds are priced and traded once per day, at the end of the trading day, at the net asset value price. Investors buy and sell mutual funds through the fund’s issuer instead of on an exchange, as the fund issuer is the one that controls the management of the fund.
On the other hand, ETFs are traded on exchanges the same way that stocks are, and investors can buy and sell them throughout the day as long as the exchange is open. The prices of ETFs constantly fluctuate as well, depending on the supply and demand on the market at the time.
Fees will also likely differ between mutual funds and ETFs due to the funds’ management style. Mutual funds typically charge higher fees than ETFs, as they are actively managed by a fund manager from the fund issuer. This fund manager is a professional within the field, and they make investment decisions on behalf of investors to keep the fund profitable.
On the other hand, ETFs are passively managed. Many ETFs track the performance of indices or a basket of securities and do not have a dedicated fund manager who manages the allocation of capital to different assets. As a result, ETFs have lower expense ratios and investors will typically find them less expensive to invest in.
Mutual funds are generally less tax-efficient than mutual funds. This is because mutual fund investors are often subject to higher capital gains taxes, due to active management of the fund. ETFs, on the other hand, typically have lower capital gains taxes due to their structure.
Transparency of pricing
As the pricing of mutual funds are disclosed only periodically, they tend to have lower pricing transparency than ETFs. This makes it difficult for investors to get a clear picture of detailed price trends. ETFs are traded on exchanges, and their historical price charts are available for investors daily.
Minimum capital requirement for investment
Finally, investor should note that mutual funds typically have a higher minimum capital requirement for investment, such as $1,000 or more. They can invest in ETFs for a much lower amount depending on the price of one share, which can range from a few dollars to a few hundred dollars.
How to choose a broker to work with
For those interested in investing in mutual funds or ETFs (or both), finding a broker to work with is essential. Investors can buy funds through the broker, who will provide a platform for them to do so and facilitate the buying and selling process.
When choosing a broker, investors should ensure that the broker offers the products they want to buy and sell, such as the specific mutual fund or ETF. They should also make sure the broker is regulated locally and operates in strict adherence to local laws, so that they can have greater peace of minds when storing their funds with them. Other factors for investors to consider include the broker’s fee structure, account tiers and types, trading platform and environment, and level of customer support available.
Choosing a suitable broker to work with is vital and can potentially increase the success of one’s investment journey. Therefore, investors should always do their due diligence and ensure they do sufficient research before deciding.
Mutual funds and ETFs both offer dynamic opportunities for investors who are interested in investing in a wide selection of assets simultaneously. What a trader should go for will depend on their goals and preferences, risk tolerance, as well as the funds they have available. Choosing between investing in a mutual fund and an ETF is only the first step for investors – the most important thing is ensuring they invest in a fund that is suitable for them and aligns with their trading preferences.