Mutual Funds vs. ETFs
The growth of exchange-traded funds (ETFs) has been explosive. In 1998, there were only 29. At the end of 2022, there were more than 2,800, investing in a wide range of stocks, bonds and other securities and instruments.
At first glance, ETFs have a lot in common with mutual funds. Both offer shares in a pool of investments designed to pursue a specific investment goal. And both manage costs and may offer some degree of diversification, depending on their investment objective. Note that diversification is an approach to help manage investment risk. It doesn’t eliminate the risk of loss if security prices decline.
Structural Differences
A mutual fund pools money from many individual investors and that money is invested according to the objectives and strategies outlined in the fund’s prospectus. The resulting collection of stocks, bonds and other securities is professionally managed by an investment company.
ETFs work in reverse. An investment company creates a new company, into which it moves a block of shares to pursue a specific investment objective. For example, an investment company may move a block of shares to track performance of the Standard & Poor’s 500. The investment company then sells shares in this new ETF. Like stocks, ETFs are listed and traded on stock exchanges and sold by broker-dealers.
Mutual funds, on the other hand, aren’t listed on stock exchanges. They can be bought and sold through a variety of other channels — including financial advisers, brokerage firms and directly from mutual fund companies.
The price of an ETF is determined continuously throughout the day. It fluctuates based on investor interest in the security and may trade at a “premium” or a “discount” to the ETF’s underlying assets. Most mutual funds are priced at the end of the trading day. So, no matter when you buy a mutual fund share during the trading day, its price will be determined when most U.S. stock exchanges close.
Watch the Account Minimum
Mutual funds often have an account minimum. For example, you may be required to make an initial investment of $500 or $5,000, depending on the fund family and such factors as whether you’re opening a retirement or nonretirement account.
By contrast, EFTs have no account minimums. You can buy as many or as few shares as you wish.
Tax Differences
There are tax differences, as well. Since most mutual funds are allowed to trade securities, a fund may incur a capital gain or loss and generate dividend or interest income for its shareholders.
With an ETF, you may only owe taxes on any capital gains when you sell the security. (An ETF also may distribute a capital gain if the makeup of the underlying assets is adjusted.)
Right For You?
Determining whether an ETF or a mutual fund is appropriate for your portfolio may require an in-depth knowledge of how both investments operate. You may benefit from including both investment tools in your portfolio. Discuss your circumstances with a financial advisor.
Copyright 2023
This article appeared in Walz Group’s September 18, 2023 issue of The Bottom Line e-newsletter, produced by TopLine Content Marketing. This content is for informational purposes only.
