One of the bigger changes the past few decades has been the rise of ETF’s, also known as Exchange Traded Funds. They are everywhere and allow you to invest in (almost) anything. But Mutual Funds are still a thing, so here are a few of the differences between Mutual Funds and ETF’s.
A Mutual Fund is an investment vehicle that is a pool of funds that is managed by the fund manager to earn capital gains and income. Mutual Funds have their own investment strategies that guide the fund manager in how to invest. Mutual Funds normally do not charge transaction fees.
An ETF is a basket of many stocks and/or bonds that trade on a major stock exchange. You purchase an ETF like you would purchase a stock. Buying an ETF is like buying all of the underlying securities, except you get to do it at one time with one purchase. It provides diversification with one security. ETF’s track specific indices, sectors or can be actively managed. You may be charged a transaction fee each time you purchase an ETF.
One major difference between Mutual Funds and ETF’s is that Mutual Funds are only priced once per day, at the end of the day. If you invest in a Mutual Fund, your investment is added to the pool of funds at the end of the day and you are given a specific number of shares equal to your investment based on the calculated Net Asset Value of the Mutual Fund as determined at the end of the day. ETF’s are priced throughout the day. You purchase them like a stock. There is a bid/ask spread (just like a stock) and you specify how many shares you would like to purchase.
Tax treatment between Mutual Funds and ETF’s is also different. You are taxed on your gain/loss in an ETF when you sell it. Mutual Funds are required to distribute gains/losses to their shareholders at the end of each year. This can be problematic if a Mutual Fund has to sell securities to honor redemptions. Those capital gains are distributed to the shareholders even if the Mutual Fund has lost money that year.
One other consideration is that ETF’s tend to have lower expense ratios. However, if you are adding funds to an account each month, the additional transaction costs of buying ETF’s each month may make Mutual Funds more attractive.