You can’t talk about investment strategies without talking about investment goals. That would be the equivalent of trying to sell someone a two-seater sports car without asking whether or not they need room for a family. Both may be fine vehicles, but what is the goal?
That’s one reason it’s important to know the difference between ETF and mutual fund investing. If you want to put money in the investments that make the most sense for your financial temperament, that’s where to begin.
The biggest difference between ETFs and mutual funds is in the management style. Mutual funds are usually actively managed while most traditional ETFs are passively managed. Active management often results in higher fees associated with the mutual fund. Traditional ETFs that are passively managed typically have lower management fees and expense ratios than comparable mutual funds. Although most traditional ETFs practice passive management, there are some “new” ETFs that are actively managed like mutual funds. These “new” ETFs have higher management fees than the traditional ETFs.
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Another big difference between ETF and mutual fund investing
ETFs trade on an exchange like stocks do and they can be bought and sold throughout the trading day. Due to this manner of trading, the price of an ETF can change throughout the trading day as well.
On the other hand, mutual funds do not trade on stock exchanges and they can only be bought and sold one time each day. Mutual funds can be purchased at the end of the trading day through a variety of avenues, including brokerage firms, financial institutions, or directly from the fund’s owner. The price is set by the fund’s net asset value (NAV), which dictates the fund’s per share market value.
Mutual funds often have higher costs associated with them, including higher tax implications because of capital gains. Due to the nature of trading securities within a mutual fund, the fund may experience capital gains or losses. They may also pay a dividend or interest income. With ETFs, it is possible to have to pay a capital gains tax, but this would only happen after you sold it. Some mutual funds will also have a minimum investment requirement, although not all mutual funds have this stipulation in place.
There is often a difference between ETF and mutual fund dividend payments, as well. With mutual funds, the dividend generated is automatically reinvested into the fund. With ETFs, the dividend is distributed to the associated brokerage.
Investing in mutual funds or ETFs have some benefits
Diversification is one of the biggest reasons to invest in either mutual funds or ETFs, and these investments can provide diversification in asset class, region, or market niche.
Overall, the decision to invest in an ETF over a mutual fund will depend on your type of investing temperament and your investment goals. For instance, if you are looking for lower fees associated with the investment, then a traditional ETF will often be a better investment decision than a mutual fund. An ETF investment would also be preferable for an investor looking for more hands-on control over the investment.
Mutual funds benefit investors who want to set up automatic purchases and withdrawals based on certain preferences. This same ability does not exist with ETFs.
For those investors interested in an index fund, either ETFs or mutual funds can be suitable. Just keep in mind that expenses will likely be higher with owning the mutual fund.
Do you have a preference behind investing in ETFs over mutual funds? Is there a reason you prefer one over the other?