Exchange-Traded Funds (ETFs) vs. Mutual Funds
When considering investment strategies, exchange-traded funds and mutual funds are almost always included in the conversation. However, for investors, the distinction between these two investments can be blurry. Although they are similar, several key differences can contribute to both the performance of the investment and their suitability to an investor.
Similarities Between ETFs and Mutual Funds
Different Investment Options—There is a wide range of ETFs and mutual funds available. You can choose from strategies like total market, growth, high-yield, sector rotation, or almost anything else that you could think of.
Diversification—ETFs and mutual funds invest in a wide range of individual stocks or bonds and occasionally more exotic investments such as commodities.
Professional Management—Both ETFs and mutual funds are managed by financial professionals who select what to invest in and charge a fee to manage the money.
Differences Between ETFs and Mutual Funds
Fee Structure—Due to the different management styles of the funds, the fee structure is often different. ETFs may have expense ratios (percentage of fund assets used for administrative, management, advertising, etc.) as low as 0.05% or lower, while the average mutual fund has an expense ratio of 0.66%. The expense ratios of index mutual funds are typically more on par with ETFs. Another possible fee with mutual funds is a sales fee or load. Suppose an investor has a short time horizon for their investment. In that case, mutual funds are generally not a good option because the load can eat away at any earnings.
Liquidity—As the name implies, ETFs trade on an exchange. This means that an investor can purchase or sell shares at the market price throughout the day. ETF shares can also be purchased on margin or sold short. In contrast, mutual fund shares trade once per day at the net asset value (NAV), set prior to trading. If you trade often or would like some control over the price at which you invest, ETFs may be the better option.
Management Style—ETFs are generally passively managed, while mutual funds are typically actively managed. As a result, many ETFs attempt to mirror a benchmark while mutual funds try to beat the market.
Minimum Investment—For an ETF, the minimum investment is the cost of a single share. For some ETFs, this can be lower than $50. Mutual funds often have investment minimums of a couple of thousand dollars or more. Especially for young investors, the investment minimums can make mutual funds a difficult investment.
Recurring Investments—Once invested in an ETF, you cannot make recurring investments or withdrawals. However, with mutual funds, both techniques are possible. Suppose you want to use a dollar-cost averaging strategy. In that case, mutual funds can be a very useful set it and forget it option.
Speak to a Financial Professional About Your Financial Situational
Suppose you are still unsure whether an ETF or mutual fund is the appropriate choice for your investment strategy. In that case, a financial advisor can analyze your situation and help suggest the best investment for your risk profile and goals.