Mutual Funds and Exchange Traded Funds

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Mutual Funds and Exchange Traded Funds – Similarities and Differences


Both ETFs and mutual funds can offer individual investors diversification and professional management that was once only afforded to wealthy investors like Warren Buffett. George Soros and Bill Gates. Mutual Funds and Exchange Traded Funds both feature a wide variety of investment strategies and styles.

 

So, what is the difference?
Mutual funds have long been a mainstay of retirement investment accounts. In fact, the first modern mutual fund appeared as far back as 1924. Exchange Traded Funds (ETFs) are a relatively newer option with the first ETF hitting the scene in 1993. As ETFs become ever more popular, it is important for investors to understand both the similarities and differences between mutual funds and Exchange Traded Funds .


In a nutshell, Mutual funds often make sense for investing in stocks of smaller foreign companies and complex yet potentially rewarding equity funds. For individual investors who want to keep things simple, ETFs, with their combination of low costs, ease of access, and emphasis on index tracking, may offer a viable and suitable alternative. ETFs ability to invest in various market segments in a straightforward way makes them useful tools to accumulate long-term wealth with a balanced, broadly diversified portfolio.


Closer Look at Similarities and Differences 


Similar: Mutual funds and ETFs are typically baskets of stocks, bonds and other assets, or sometimes just a single asset such as gold.


Similar: ETFs are “funds” registered with the Securities and Exchange Commission as investment companies under the Investment Company Act of 1940 and the shares they offer to the public are registered under the Securities Act of 1933.


Similar: Like any investment, ETFs can expose investors to any number of risks. For example, just like any stock, ETFs can decline in price.


Similar: Mutual funds and ETFs both have expense ratios. An expense ratio is the annual fee that all mutual funds or ETFs charge their shareholders, including 12b-1 fees, management fees, administrative fees, operating costs and all other asset-based costs incurred by the fund. It is expressed as a percentage of assets. These fees will vary based on the type of fund .

 

Difference: Timing of unit or share price
A mutual fund is only priced once a day… at the end of the day. The price is based on the closing value of the mutual fund’s underlying holdings (known as its Net Asset Value, or NAV). An investor who wants to buy or sell shares of a mutual fund can submit an order at any time during the day, but that order will not be executed until the end of the day at the mutual fund’s determined NAV.
An ETF can be bought or sold at any time during the trading day on an exchange just like stocks through a brokerage account using the same types of orders that are placed for shares of stock. Also, its price, which can fluctuate significantly, is driven by market forces and the value of its underlying portfolio. ETFs have bid-ask spreads just like stocks, so investors generally get prices that can differ from the underlying portfolio value.


Difference: Unlike with mutual funds, investors do not buy shares directly from the fund. Instead, an ETF contracts with financial institutions… called “Authorized Participants.”  The APs create and redeem shares from the ETF and sell them to investors on public exchanges. The unique authorized participant/share create-and-redeem structure of ETFs is designed to keep an ETF’s market prices close to the value of its underlying portfolio.


Difference: Expense Efficient - ETFs tend to have lower expense ratios. These are annual fees that funds charge investors. They are lower than traditional mutual funds and index mutual funds. The average U.S. based ETF has an expense ratio of 0.44 percent, according to Morningstar . That means the average ETF would cost $4.40 in annual fees for every $1,000 invested. In contrast, the average U.S.-based mutual fund has an expense ratio of 1.22 percent, while the average annual cost of a U.S.-based index mutual fund is 0.91 percent.


Difference: Mutual Funds do not have brokerage commissions that must be paid when buying or selling. ETFs investors will likely have to pay brokerage commissions on top of the fees delineated by the fund’s expense ratio.


Difference: ETFs generally reduce capital gains distributions to investors and can be more tax efficient than mutual funds. It’s also important to understand that while ETFs might reduce tax liabilities while an investor is holding shares, an investor will have to pay capital gains tax on any gain when he or she ultimately sells.


Make an Informed Investment Decision
It is vitally important for Servicemembers and Veterans to read an ETF’s prospectus and talk to an investment professional to make sure they understand its strategy and the risks they might encounter.


ADDITIONAL Information at: Trends in the Mutual Fund and ETF Market


Resources and References

 

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© 2017 by SafeHarbor Financial Collaboration Services

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