A key thing for investors to keep in mind is the makeup of their portfolio, or the mix of their investments. A diversified portfolio invests money in various types of assets. Thus, if one particular investment fails, the success of the others will ensure you don’t lose all your money.
Two investment options for this strategy, called diversification, are mutual funds and ETFs. But they each have unique traits that set them apart. Here is the basic information you need to tell the difference between a mutual fund and an ETF.
WHAT IS A MUTUAL FUND?
Mutual funds are a type of investment where multiple investors pool their money together for a company or professional to manage. That manager then takes the funds and invests them in various assets. It is also up to the manager how much money is put into which security.
This is an active management style. Often, the manager tries to beat a benchmark and thus may charge more than an ETF.
WHAT IS AN ETF?
ETF stands for “exchange-traded fund.” They’re traded on the major stock exchanges, like the NASDAQ and New York Stock Exchange, throughout the trading day. Similar to mutual funds, they let investors put their money into multiple securities. A fund manager controls where the money is put based on the investment’s goal.
Some ETFs track market indices, like the S&P 500 or the Dow Jones Industrial Average, in a passive management style. So, the fund manager isn’t actively choosing how to buy and sell with the fund. They’re trying to match the success of the chosen index.
HOW ARE MUTUAL FUNDS AND ETFS DIFFERENT?
While ETFs and mutual funds let you invest in multiple assets, they have their differences. To start, you can trade an ETF like a stock throughout the trading day. In contrast, investors need to purchase mutual funds at the very end of the trading day according to their net asset value (NAV). So, ETF prices fluctuate, whereas mutual funds’ costs are fixed per day. ETFs are sometimes the cheaper investment option as well and are typically more tax-efficient.
Managers generally take a more active strategy with mutual funds versus ETFs. Instead, the ETF matches an index rather than tries to outperform it, like the mutual fund. However, you can find various funds of each type with different goals.
Between mutual funds and ETFs, the former is more popular. According to the Investment Company Institute (ICI), the U.S. holds a combined $25.80 trillion in mutual fund assets, whereas the nation only has $6.33 trillion in ETF combined assets. Part of that is due to the popularity of mutual funds in retirement plans like 401(k)s. Still, ETFs are growing rapidly.
IN WHAT TYPES OF ACCOUNTS CAN I PURCHASE MUTUAL FUNDS AND ETFS?
You have a couple of options for the type of account to begin your investing. The choice may depend on your financial goals. For example, you may want to start saving for retirement. In that case, you can research employer-sponsored retirement accounts, such as an IRA or 401(k) plan.
However, goals outside retirement may require different accounts. For example, if you want to build wealth, consider opening an individual or joint brokerage account. Or, if your objective is to save money for a child’s education, 529 college saving plans and UGMA/UTMA accounts may also work.
IS A MUTUAL FUND OR ETF BETTER FOR ME?
There is no straightforward answer– it simply depends on your investment strategy. Both give you broad diversification and access to niche market investments without hand-picking individual securities.
If you are more interested in active trading, then there are some ETFs available for you. That can give you more control over your holdings. In contrast, mutual funds are managed by a professional and at the mercy of market fluctuations.
However, you will likely find more low-cost options with a mutual fund than an ETF. Both options have their benefits and drawbacks. So, overall, finding the best investment is up to your goals and preferences.