ETF vs mutual funds are different in terms of minimum investment, costs, prices, as well as in how they are managed and exchanged.
ETFs and mutual funds have lots of similarities. Both refer to professionally managed "pools" of individual securities, such as stocks or bonds. Both provide investors with exposure to a diversified portfolio consisting of numerous asset classes and specialized markets without having to buy each asset individually. However, there is also a great deal of differences between ETFs and mutual funds.
What Differentiates ETFs from Mutual Funds?
A mutual fund is a type of investment product that consists of a portfolio of stocks, bonds, or other securities. It is managed by seasoned financial experts who work together in an asset management company. Each mutual fund is divided into units or shares, which can be bought by lots of investors directly from the company.
See Also: How Do Hedge Funds Work?
An ETF operates much like a mutual fund, with one additional clause: it can be traded on the stock exchange. For that reason, some folks call ETFs "publicly traded mutual funds".
Differences between ETF vs mutual funds go beyond that point, though. There are also distinctive features in the minimum investment, costs, prices, as well as in how they are managed and exchanged.
- Minimum investment: ETFs are traded like stocks, so we only have to prepare funds as much as the shares we wish to buy. The minimum investment in ETFs is equal to the price of a single share. On the other hand, mutual fund minimum investments often start at a fixed dollar amount and are not contingent on the share price of the fund.
- Costs: We can buy mutual funds either without any commission fees or with small amounts of subscription/redemption fees. However, ETF cost structures are more complicated. ETF costs may include but are not limited to trading comissions, bid/ask spread, and premium/discount to NAV.
- Prices: Net Asset Value (NAV) in mutual funds is calculated once at the end of market hours, while ETF share prices will change in real-time during trading hours.
- Fund management: The majority of ETFs are passive investments linked to the performance of a specific index, although some of them may be actively managed. On the contrary, most mutual funds are actively managed by professional fund managers.
- Trading rules: We can buy and sell ETFs in the stock market against other market participants. But we can only buy and sell mutual funds directly from fund managers and their agents.
Should I Invest in ETFs or Mutual Funds?
ETFs and mutual funds potentially lower your risk and exposure, while helping to diversify your portfolio. Yet, both are designed for different types of investors.
ETFs are more suitable for experienced traders who are used to trade actively in the market. Meanwhile, mutual funds are the best choice for novice investors and passive investors—those who are not used to trade every day but seek to invest a certain amount of funds regularly.
Investing in ETFs requires a higher degree of understanding of how the market works. We should also be able to analyze the market, either fundamentally or technically, to determine the right entry and exit points.
Compared to ETFs, investing in mutual funds is like a walk in the park. The hardest part of the job is determining which mutual funds to buy. Afterward, we can simply deposit our money and let fund managers work for us.