ETF vs. Mutual Fund: Let’s Examine The Pros & Cons of Each

By November 21, 2018Trader Tips, trading
ETF vs. Mutual Fund: Let's Examine The Pros & Cons of Each

ETF vs. Mutual Fund: Let’s Examine The Pros & Cons of Each

ETF versus mutual fund: Is there a winner?

Most investors are interested in adding diversity to their portfolio, and both ETFs and mutual funds are great ways to do so quickly and efficiently.

These two types of investments both offer the ability to invest in funds which represent a series of assets/investments all in one fell swoop.

But what’s the difference between an ETF and a mutual fund, and which one is better suited for you? Let’s examine both investment types, including the pros and cons of each:

What are ETFs?

ETF is an acronym that stands for “exchange-traded fund,: An exchange-traded fund is a specific type of fund that owns underlying assets.

Within the umbrella of ETF, you’ll find various types of funds, including:

  • Index ETFs: These are designed to track a particular index, like the S&P 500.
  • Commodity ETFs: These are designed to track the price of a commodity, such as gold.
  • Inverse ETFs: These are designed to profit from a decline of the underlying market or index.
  • Actively Managed ETFs: These are designed to outperform an index rather than to track an index.
  • Industry ETFs: These are designed to provide exposure to a particular industry, such as high tech.
  • Foreign ETFs: Designed to track non-US Markets, such as the Japanese Nikkei Index.

The ownership of these underlying assets is divided into shares. As an ETF shareholder, you’re entitled to a piece of the profits, which can come through earned interest or dividends. If at some point the fund is liquidated, you may also receive some of the residual value.

How to buy an ETF

During regular trading hours, ETFs can be bought and sold just like a stock. ETFs have their own ticker symbol and price data which can be monitored throughout the trading day on a platform like StocksToTrade.  

Why invest in an ETF?

Here are some of the reasons why ETFs are enticing to investors:

  • You can invest your assets using stock index and bond ETFs, and adjust the allocation based on your risk tolerance and goals.
  • They offer the opportunity to add alternative assets, such as gold, commodities, or emerging stock markets.
  • They’re easy to buy and sell, meaning you can get in and out of the market quickly.  

ETF considerations

  • Unlike a company stock, the number of shares outstanding for an ETF can change on a daily basis, because new shares are constantly being created and existing shares are constantly being redeemed.
  • Ownership of the fund can be bought, sold, or transferred in much the same way as stock shares since ETF shares are traded on the same exchanges.
  • Some thinly traded ETFs have wide bid/ask spreads.
  • ETF sales are not settled instantly. They’re not settled for three days after the transaction, so your funds won’t be at the ready for other investments for a few days.

What are Mutual Funds?

A mutual fund is an investment that is made up of an amount of money that has been collected from a variety of different investors.

This money is managed by a professional manager who invests the money in a variety of different assets that might include stocks, bonds, commodities, and real estate. The idea is that they’re trying to generate income for the investors by intelligently investing their money.

Usually, the manager will create a prospectus for the mutual fund, detailing the structure of the portfolio so that they can see if it is aligned with their investment goals.

There are four key types of mutual funds, which are classified by their principal investments:

  • Bond funds: These funds invest and trade in fixed income or debt securities
  • Money market: These funds invest in short-term securities that have high quality, liquid debt.
  • Stock funds: These funds (also called equity funds) invest in common stocks.
  • Hybrid funds: These funds include both bonds and stocks or other convertible securities.

Additionally, there are three primary structures for mutual funds:

  • Open-end funds: These funds buy back or sell their shares every day at the NAV (net asset value), based on the prices of the securities owned by the fund.
  • Closed-end funds: These funds issue shares to the public just once, when they are issued as an IPO. These shares are then listed on stock exchanges. Investors can sell their shares to other investors, but not back to the fund.
  • Unit investment trusts: These funds are issued to the public only once: when they are created. Investors can redeem shares directly with the fund, or wait until the fund is terminated. They don’t have a professional manager, but rather the portfolio is locked at the time of creation.

How to invest in a mutual fund

As an investor, you can buy into a mutual fund in various ways. One way is through a retirement account; many institutions allow mutual fund trading through their websites.

Another way is to buy directly through a financial institution. Most investment firms will offer several different mutual funds.

A third way is to use a brokerage account: Sites like TD Ameritrade and Charles Schwab offer the opportunity to invest in mutual funds.

Why invest in a mutual fund?

Here are some of the reasons investors are drawn to mutual funds:

  • Daily liquidity: The liquidity is good, and investors can redeem their shares at any time.
  • Professional management: The mutual fund is created/overseen by a professional who really knows the market better than you!
  • Access to investments: Mutual funds allow you to participate in investments that might otherwise only be available to larger investors.

Key Differences Between Each

Here are some of the key differences between ETFs and mutual funds:

  • Investors buy mutual fund shares from the fund itself or through a fund broker, rather than from other investors, which is the case with stocks and ETFs.
  • The minimum investment for stocks and ETFs are just one share; a mutual fund might require an investment of $1,000 to $5,000.
  • Mutual funds can only be traded once a day, after the markets close. Stocks and ETFs are traded throughout the day.
  • A mutual fund’s NAV is determined at the end of the trading day, while stocks and ETFs fluctuate during the trading day.

Which is Best For You?

There’s no easy answer to this question. Rather, it’s a question of your personal style.

For example, does the idea of someone else managing the fund sound enticing? A mutual fund may be more up your alley.

Do you prefer investments that offer an easy entry and exit and a low initial investment? An ETF might be more your speed.

Like any other investment, it’s important to do plenty of research into the fund in question before executing an order.

 

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Conclusion

When it comes to deciding between an ETF or a mutual fund, there’s not one clear winner — it really depends on you as an investor. You’ll have to consider your account size, risk tolerance, and investment goals.

By reviewing this post, we hope you’ve gained plenty of food for thought to help you consider which type of investment is better for you.

Which do you prefer: ETFs or mutual funds?

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