Exchange-Traded Funds (ETFs)
Exchange-Traded Funds (ETFs) are traded throughout the day, so you may see the value of an ETF fluctuate during trading. When you buy an ETF, you buy it at the current market price. You can purchase one share or multiple shares depending on what you can afford at the current market price.
Typically, the expense ratios for ETFs are lower than most mutual funds. In theory, this lower expense ratio can provide a slight return advantage compared to index funds for the investor. For example, the expense ratio for the Vanguard S&P 500 ETF (VOO) is 0.03%, whereas the expense ratio for the mutual fund version Admiral Shares (VFIAX) is 0.04% – although both have nearly the same performance returns.
ETFs are the latest iteration of funds created to enable access to investments at lower costs compared to mutual funds. Fractional shares allow investors to purchase a portion of the financial ETF instead of a whole unit.
Mutual Funds
You can buy a mutual fund at any time of the day, but fund managers cannot execute trades within the fund until the end of the day. The price at which you buy or sell a mutual fund is not the actual price but the net asset value (NAV) of the shares that constitute the fund. When you invest in a mutual fund, your money is used to trade the fund’s NAV at the end of the trading day.
For example, it is common for mutual funds to have a minimum purchase requirement, such as $3,000. So if shares cost $100, you would buy 30 shares.
Mutual funds can either be passively managed or actively managed, while very few ETFs are actively managed. ETFs are generally passively managed, making them more similar to index mutual funds.
Special Considerations
Both mutual funds and ETFs allow you to buy a basket of securities in a single transaction. Both typically invest according to an announced or implied objective, such as growth, value, or income. Additionally, both usually invest in a specific class of stocks or bonds, such as large-cap stocks, foreign stocks, or intermediate-term bonds.
ETFs are the newest version of funds created to enable access to investments with lower costs and prices compared to mutual funds. The modern phenomenon of fractional shares enabled by technology allows the purchase of a portion of an ETF instead of a whole unit at the same price as corporate stocks.
You can use mutual funds and ETFs to achieve diversification in your portfolio. However, you can also use them together to complement each other. For example, some investors prefer to use ETFs for sector funds and mutual funds for actively managed selections.
Typically, index-based ETFs are cheaper to buy, so you can purchase them if you are limited in capital. For instance, the price of the Vanguard S&P 500 ETF (VOO) was about $407 on August 10, 2021, while the minimum for the mutual fund Admiral Shares (VFIAX) for the same index is $3,000.
ETF vs. Mutual Fund
Mutual Funds ETFs
- Trading Time: Fund managers execute trades after market hours
- Price
- Purchase: Acquired at net asset value
- Costs: Cost ratio is higher
- Management: Can be managed passively and actively
- Automation: Automated transactions can be set up
Mutual Funds
- Trading time: Can be purchased at any time of the day
- Purchase price: Acquired at net asset value
- Costs: Cost ratio is lower
- Management: Can be managed passively and actively
- Automation: Automated transactions can be set up
Frequently Asked Questions (FAQs)
Which is better, an ETF or a mutual fund?
From the perspective of the average investor, there won’t be much difference between ETFs and mutual funds. As long as they track the same investments using similar methods, they should perform similarly. One advantage of ETFs is that they typically incur lower capital gains taxes due to slight differences in how ETFs and mutual funds treat investor transactions. This difference does not apply to those investing in tax-protected retirement accounts.
What is a leveraged ETF?
Leveraged ETFs contain a complex mix of derivatives designed to amplify the movements of the underlying index. For example, if the S&P 500 rises by 1%, a triple-leveraged ETF like SPXL will rise by approximately 3%. When the S&P drops by 1%, SPXL falls by about 3%.
Mutual funds sometimes use leverage, but leveraged index strategies pose additional risks for long-term holding investors, so many traders prefer the trading capabilities of leveraged ETFs.
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Sources:
- Vanguard. “Vanguard S&P 500 ETF (VOO).”
- Vanguard. “Vanguard 500 Index Fund Admiral Shares (VFIAX).”
- Securities and Exchange Commission. “Mutual Funds and Exchange-Traded Funds (ETFs) – A Guide for Investors.”
- Direxion. “SPXL SPXS.”
- Securities and Exchange Commission. “Leveraged and Inverse ETFs: Specialized Products With Extra Risks for Buy-and-Hold Investors.”
Source: https://www.thebalancemoney.com/differences-between-mutual-funds-and-etfs-2466791
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