What Is The Difference Between An ETF Vs. Mutual Fund?
What Is The Difference Between An ETF Vs. Mutual Fund?
The most important component of successful investing is
The longer your money is invested, the more it will grow. Which means you need to start investing right away like the second you finish reading this article type of right away!
And there are lots of ways to invest. Some of them are riskier than others likeday tradingandcryptocurrencies. Some of them are easier than others like ETFs and mutual funds.
Because time is of the essence, you dont have time right now to learn enough to successfully target individual stocks to invest in.
You need a quick and relatively foolproof method of investing, something any American can do with whatever amount of personal finance knowledge they have right this minutewithouthiring an investment advisor. ETFs and mutual funds both fit that bill.
But is one better than the other? Is there any difference when it comes to an ETF vs. a mutual fund? Well break down all the details so you can stop wasting time andstart investing.
We know that youre chomping at the bit tostart investingand in your hurry, you might think that ETFs and mutual funds are the same things, so it doesnt reallymatterwhich one you choose.
Both an ETF and a mutual fund can give individual investors a low fee,well-diversified portfolioofstocks, bonds, and other assets.
But there are some key differences, and when you understand those differences, youll be able to make a more informed decision when it comes to choosing the best kind of investment for you.
ETF stands for Exchange Traded Fund. Its a fund that can be made up of stocks, bonds, commodities, or other assets that are designed to track a particular index like the Dow Jones, NASDAQ-100, S&P 500, etc.
Just like stocks, ETFs trade daily on stock exchanges and their prices fluctuate across the day. When you buy a share of an ETF, youre buying shares of a portfolio that tracks the yield and return of the index it tracks. ETFs dont aim to beat their tracked indexs performance, just to replicate it. An ETF isnt trying tobeatthe market but tobethe market.
Mutual funds allow individual investors to invest a pool of money with fellow investors to buy a basket or portfolio of stocks, bonds, or other securities. The price of a mutual fund is determined by the total value of the assets in the portfolio.
Mutual fund managers make decisions on buying and selling securities with the goal of beating its benchmark, an index like the ones mentioned above, Dow Jones, NASDAQ-100, S&P 500, etc.
Often when you see a straight up,This vs. That,there is a clear answer, one thing is clearly better than the other. Is that true when it comes to an ETF vs. Mutal Fund? Lets break it down.
ETFs are usually passively managed. Rather than having a fund manager select individual securities to build a portfolio, the investments are automatically chosen to match an index or part of the market.
This is part of the reason ETFs have a lower expense ratio compared to mutual funds. An expense ratio is how much of a funds assets go forpaying administrative and operating expenses.
Not paying a fund manager to actively manage a fund means ETF investors will pay fewer fees than will mutual fund investors.
ETFs trade like stocks. The price is determined by what investors think the market value is and you can buy and sell shares throughout the day.
Mutual funds, on the other hand, can only be bought and soldafterthe stock market closes at the end of the trading day and the price is based onCurrent Net Asset Value. So ETFs are more flexible than mutual funds.
ETFs generally disclose their holdings every day while actively managed mutual funds only do so quarterly or semi-annually.
If someones job is investing other peoples money,they must be good at it, right?They wear a fancy suit and work out of a fancy office. They surely know better than us amateurs right?
Most mutual funds are under professional management. A fund manager tries to beat the market by hand choosing individual securities based on their expertise. This practice is known as active management, and it comes at a cost.
Well, so what?If portfolio managers and getting mutual fund investors higher returns, its worth the cost.
Butdoactively managed funds outperform the market?No, they dont.
For the 15-year period of April 1, 2001, through March 31, 2016, only 29% of actively-managed U.S. large company funds were able to beat the S&P 500 Index.
So far this has been pretty one-sided in favor of ETFs but heres a point in the mutual fund column. You can trade mutual fundswithout paying a commission.Thats not true of most ETFs, and the ones that are commission free will have higher expense ratios to make up for it.
Pick the right mutual fund though. Front-end or back-end load paid when buying or selling is about the same thing as paying commission. There are no-load funds you can buy and sell with no broker commissions.
Taxes and interest are two of the most significant expenses in life, so we want to (legally) avoid them both when we can. If youre looking to avoid taxes, specificallycapital gains taxes,ETFs have an advantage over mutual funds.
A person doesnt know how much they have to be thankful for they have to pay taxes on it.
When you invest in an ETF, you only incur capital gains taxes when you sell the fund. Mutual fund investors will pay capital gains taxes when the shares within the fund are traded during the life of the investment.
We always encourageeveryoneto invest, but some people dont because they think you have to have a lot of money to do so.Not true!There are ETFs and mutual funds that dont require a big initial investment but ETFs generally have lower initial investments than do mutual funds.
Both ETFs and mutual funds allow investors to diversify their investments in relatively low risk (all investing comes with some risk) way. Which you choose depends on your investment strategy.
I hate those kinds of answers.Well, theyre both great in their own ways.Its like when you ask a parent who their favorite child is. Theyallhave one but they wont admit it and give some bs answer. (I know this is true because my parents told me Im the favorite!). So here is the non-bs answer.
If any of these apply to you, you should consider an ETF:
If youve been with LMM for a while, youre probably familiar with Vanguard. We talk about Vanguard index funds but Vanguard also offers commission-free ETFs.
If any of these apply to you, you should consider a mutual fund:
You want variety (there are countless types of mutual funds to choose from)
Youd prefer automatic investment options (you can set recurring transfers into your mutual fund)
You believe in the ability of a fund manager to beat the market
If you have a401kthrough your employer, you may be familiar with Fidelity. Fidelity provides 401k retirement accounts for businesses and is one of the best known mutual fund companies as well.
If you want to invest in an ETF or mutual fund, Morningstar is a good place to research either. They rate both with an easy to understand one to five-star basis, one being poor and five being the best.
Thats the ETF vs. mutual fund smackdown. They have more similarities than differences and the important thing is thatyoure investingso you can comfortably choose either. Both are easy, low-risk ways to invest your money and diversify your portfolio.
Candice Elliottis a substantial contributor to Listen Money Matters. She has been a personal finance writer since 2013 and has written extensively on student loan debt, investing, and credit. She has successfully navigated these areas in her own life and knows how to help others do the same. Candice has answered thousands of questions from the LMM community and spent countless hours doing research for hundreds of personal finance articles. She happily calls New Orleans, Louisiana home-the most fun city in the world.
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