Choosing Between ETFs and Mutual Funds
There is a sea of difference between investing exchange-traded funds (ETFs) and investing in mutual funds.
Both of these funds hold portfolios of stocks and bonds. Sometimes, they hold other asset classes like commodities and precious metals.
However, they must follow the same regulations that tell them what they can own, how much can be invested in one or few holdings, and how much they can borrow relative to the portfolio size.
When choosing between ETFs and mutual funds, read the following insights.
Exchange- Traded Funds
As the name implies, exchange-traded funds trade on exchanges, similar to common stocks. On the other side of the trade is an investor and not a fund manager.
You can buy and sell any time during the trading session at whatever the price is, depending on market conditions. There is also no minimum holding period.
This is extremely important for the case of ETFs that track international securities, where the asset price hasn’t been yet updated to reflect new information, but the US market valuation has done it. What this means is that ETFs can reflect the situation in the market faster than mutual funds.
Also, most ETFs track indices, which means they try to match the returns and movements of an index by making a portfolio that matches the index components are closely as possible.
The ETF structure also comes with tax efficiency too. ETF and mutual fund investors are taxes each year depending on the gains and losses incurred within the portfolios
However, ETFs engage in less internal trading, which means fewer taxable situations.
When you invest in mutual funds, the transaction happens between you and the company that manages the fund. And the transaction can go either directly or through a brokerage firm.
Purchasing a mutual fund is done at the net asset value of the fund based on the price when the trading day ends and when the market closes. If you place the order after the close of the markets, the purchase will be executed at the market close the next day.
When you decide to sell your shares, the transaction process is the same but in reverse. However, some mutual funds impose a penalty for selling early, often sooner than the first 90 days since you bought.
Mutual funds can also track indices, but most of them are actively managed. In such cases, the people who operate the funds select a variety of holdings to try to beat the market index which they use as benchmarks for performance.
And that setup is a bit more expensive, since actively managed funds must pay the analysts, economic research, visits in companies, and others.
This also means that it’s typically much more expensive to run and own a mutual fund than an exchange-traded fund.
Both mutual funds and ETFs are open-ended. This means that the number of outstanding shares can be tweaked up or down to adjust with supply and demand. Choosing between the two funds will ultimately depend on the trader’s preference.