How do Mutual Funds and ETFs Differ?
When it comes to investing in equities, it’s generally most efficient to buy mutual funds or ETFs (Exchange-Traded Funds), which are both “baskets of goods.” You can purchase equity in a variety of companies by simply purchasing shares of funds that spread your assets across those companies. This saves you from buying individual stocks and worrying about when to trade from those positions in favor of other companies. Mutual Funds and ETFs at their core, are similar, and generally serve the same purpose, but they have some distinct differences. In this article, we will look at those differences and highlight some critical features of each.
How Are They Managed?
A key difference between mutual funds and ETFs is that mutual funds can, and often are, actively managed by a fund manager. The performance of the fund is closely tied to the fund manager. If they have been managing the fund for an extended period, with a good track record, then the performance is a valuable tool for evaluating the fund. However, if the fund manager has left or been replaced, knowing that the fund’s track record should not be counted upon for reliable evaluation is important. On the other hand, ETFs are generally more process-oriented in their management style. They are passively managed and structured to compete with the performance of a particular index. Some mutual funds fit this description as well.
How Are They Traded?
Another critical difference between these two types of funds is how they are traded. Orders for mutual funds are executed once per day, with the price based on the Net Asset Value (NAV) calculated once daily. Each investor pays the same price as all other investors buying that same fund on that same day. As a result, you don’t see a price fluctuation intraday. ETFs trade like individual stocks. They are bought and sold on an exchange, reflecting lots of price fluctuation throughout the trading day. Because the price fluctuates throughout the day, your cost will likely differ from another investor buying the same fund on the same day.
Are there minimum investments?
Mutual funds do not have to be purchased in whole shares, making them a good option for people just starting to invest. ETFs do not require a minimum initial investment, though they can only be bought in whole share form at their market price. Because of this, buying ETFs for people who are just beginning to invest from zero can be tricky because you may not have enough capital to buy a full share.
What are the costs?
Mutual funds can be bought without trading commissions. But, besides their operating costs, they can carry other fees like sales loads or short-term redemption fees. ETFs have a bid/ask price spread and a premium/discount to the NAV. The price you pay for an ETF may differ from the value of the ETFs underlying holdings. ETFs generally have a cheaper expense ratio than mutual funds. These costs are baked into the price you pay for the fund and won’t be tacked on to your management fee. Also, the expense ratio is taken into account when looking at the performance of the fund.
Which is right for me?
The answer really depends on your situation and what accounts you have. As stated above, each has certain advantages, depending on how much money you’re investing or how long you plan to stay in each fund. Discussing your needs with a financial advisor to help you determine the right fit for your investment portfolio is important. Schedule a meeting with one of our advisors today if you’d like to learn more.
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