05 Jul What’s the Difference between a Mutual Fund and an ETF?
There can be a lot of confusion when it comes to understanding the different types of investments available today, but it’s important so that you can make the best choice for you and your financial situation. You definitely want to understand how the different options make money and how much money you can expect to earn.
Rather than getting overwhelmed about all the choices between stocks and bonds, mutual funds, annuities, and more, do your research and confidently make your decision. In this article, we will take a closer look at the similarities and differences between Mutual Funds and Exchange-traded Funds (ETF).
Mutual funds have been available and popular among investors for quite a while, yet ETFs are relatively new and are becoming more popular because they can be cost and tax efficient.
Similarities between Mutual Funds and ETFs
Both mutual funds and ETFs consist of a pool of investments, such as stocks, bonds, and sometimes precious metals, which are selected by the person or team who manages the investment. Because these methods can bundle 100-3000 different securities together, investors enjoy diversification of their portfolios.
There are procedures in place that regulate what exactly can be owned, how much of any one product can be designated in the fund, and how much can be borrowed depends on the size of the portfolio.
Beyond these similarities, there are some notable differences as well.
Differences between Mutual Funds and ETFs
Determining Price
The price of a mutual fund is determined when the market closes each day, but the price of ETF varies throughout the trading day. Why? Because investor demand drives ETF prices whereas Mutual Funds are traded at the end of the day.
Fees
There are expenses associated with Mutual Funds, including redemption fees (to dissuade too much turnover), operating expenses (like advertising and distributing costs), and commission or “loads” (paid when you buy or sell). Over a year, costs for maintaining a Mutual Fund can be 0.1% – 3.0%.
By contrast, the expenses incurred by ETFs usually are lower because operating costs are less and they don’t have loads. Mutual Funds are often carefully managed and analyzed by teams of people, which makes them pricier. ETFs are considered “passive” and are cheaper because buyers and sellers are working directly with each other. The middleman is cut out because much of the business is done electronically by the sellers and buyers. ETFs are regarded as more efficient because of these reasons.
Index Tracking
For the most part, ETFs try to coincide with the returns and prices of an index more than Mutual Funds do. This also contributes to keeping operating costs lower for ETFs and may improve your investment return rate as well.
It’s worth noting, however, that Mutual Funds that are indexed usually won’t have sales loads.
Taxes
It’s no secret that investors are taxed yearly based on whether their ETFs or Mutual Funds had gains or losses. However, because of how ETFs are structured, there’s less internal trading, which means not as many “taxable events” are created. This is because the need to sell ETFs is reduced due to their redemption structure.
Because the tax efficiency of ETFs is better, investors can often dodge capital gains distributions, which can also improve the return rate even if an ETF and a Mutual Fund are tracking the same index.
Minimums
Most mutual funds have investment minimums while ETFs don’t. This makes ETFs attractive to all kinds of buyers, large and small. “Smaller” investors aren’t unfairly penalized because they don’t have as much to invest. On the contrary, the field is much more level for everyone.
Should You Switch?
Now that you understand the differences between Mutual Funds and ETFs, you’re thinking about switching your Mutual Funds to ETFs, right?
Not so fast. Remember that ETFs are pretty new whereas Mutual Funds have been around for a long time. As a new investor, you may find comfort in the stability and predictability of a Mutual Fund even though it may cost a bit more for someone else to manage the mutual fund and you may pay more upfront in taxes … or you may find that jumping right in to ETFs as a rookie could be beneficial for you.
As an experienced investor, switching your mutual funds over to ETFs could result in capital gains taxes, so consider that before you make your decision. Will it really be worth it in the long run or not?
Keep in mind that your time is valuable, and if you switch to ETFs, you’ll have to put the time in to manage your portfolio yourself. And eventually, you’ll end up paying taxes, so it’s not like you’re avoiding the taxes with ETFs; you’re just delaying paying taxes.
Seek Counsel
Either way, you need to consider the risk versus the reward. Which one is better for you is something only you can answer after doing your homework. When in doubt, contact a skilled investment advisor like the ones at www.russellandcompany.com who can steer you in the right direction based on your goals and capital.
This newsletter was prepared by a third party company to be used on the Russell & Company and Simple Money Tips for Women websites.
Mutual funds and Exchange-traded funds (ETF) are sold by prospectus only. Before investing, investors should carefully consider the investment objectives, risks, charges, and expenses. The fund and ETF prospectus provides this and other important information. Please contact your representative or the Company to obtain a prospectus. Please read the prospectus carefully before investing or sending money. ETFs do not sell individual shares directly to investors and only issue their shares in large blocks, ETFs are subject to risks similar to those of stocks.
