Mutual funds and exchange-traded funds (ETFs) are both baskets of individual securities that offer a variety of asset classes and niche markets that can help investors diversify their portfolios. There are differences between them, however, that could make one option preferable for a particular investor.
MUTUAL FUNDS
Mutual funds are either actively managed or pinned to an index. Earnings can be taxable and are paid as dividends, capital gains distributions, or increases in the share price. Mutual funds allow automatic investments and withdrawals. Share prices are calculated at the end of each trading day when all trades are executed. Not all funds have a sales fee but may charge other fees and expenses, which vary.
EXCHANGE-TRADED FUNDS
ETFs are traded on an exchange, like stocks, throughout the day, so investors can purchase as few as one individual share. Most ETFs follow an index, but some are actively managed. Passively managed ETFs may have lower expenses and can be tax efficient because trades are only made to match changes in their index. However, some trades can trigger the capital gains tax.
Index funds can be less volatile than those that follow a specific sector. ETFs can be relatively inexpensive, however, investing in them does include certain costs, which may include: operating expense ratio (OER), trading costs, commissions (if applicable), bid/ask spreads, and changes in discounts and premiums to an ETF’s net asset value.
Your financial professional can review costs and help you decide whether mutual funds or ETFs will fit into your investment plan.