What is the difference between ETFs and mutual funds?

While ETFs are traded like stocks throughout the day like stocks, mutual funds are only traded at the end of the trading day when their net asset value (NAV) is calculated.

Jan 11, 2025 at 09:24 pm

Key Points:

• Definition and Structure: ETFs (Exchange-Traded Funds) and mutual funds are both investment vehicles that pool money from investors to purchase a diversified portfolio of assets. However, ETFs are traded like stocks on an exchange, while mutual funds are not directly traded on an exchange.
• Investment Objectives: Both ETFs and mutual funds can track a wide range of benchmarks, including stock indices, bonds, commodities, and real estate. However, some ETFs may have more specific investment objectives, such as focusing on specific sectors, industries, or investment styles.
• Trading Mechanisms: ETFs trade throughout the day, while mutual funds only allow trading at the end of the trading day when their net asset value (NAV) is calculated.
• Fees and Expenses: ETFs typically have lower operating expenses than mutual funds. Mutual funds may charge sales loads or redemption fees, which can reduce the returns compared to ETFs.
• Tax Treatment: ETFs and mutual funds are taxed differently depending on the underlying assets. Dividends received in an ETF may qualify for the dividend received deduction, while distributions from mutual funds may be subject to capital gains or dividend income tax.

Differences in Detail:

1. Definition and Structure

• ETFs are required to register with the Securities and Exchange Commission (SEC) as investment companies, and are classified as either passively managed index funds or actively managed closed-end funds.
• Mutual funds are also investment companies registered with the SEC, but they are structured as corporations or trusts.
• ETFs are listed and traded on stock exchanges, just like individual stocks.
• Mutual funds are not listed on stock exchanges and are not traded on the open market.

2. Investment Objectives

• Index ETFs track a specific market index, such as the S&P 500 Index, and aim to provide returns that closely align with the performance of that index.
• Mutual funds can have a broader range of investment objectives, including growth, value, income, or a particular industry or sector focus.

3. Trading Mechanisms

• ETF shares are continuously priced and traded throughout the day on the exchange where they are listed.
• Mutual funds are only priced once a day, after the closing bell of the stock market.
• The real-time pricing of ETFs allows investors to react to market conditions and make trades throughout the day.

4. Fees and Expenses

• ETF expense ratios are typically lower than mutual fund expense ratios.
• Mutual funds may charge sales loads (a fee paid to brokers when buying shares) or redemption fees (a fee paid when selling shares), which further increase the overall cost of investing.

5. Tax Treatment

• Dividends received in an ETF may qualify for the dividend received deduction, which reduces the taxes on long-term capital gains.
• Distributions from mutual funds may be treated as capital gains or dividend income, depending on the type of fund, which can result in higher tax liability.

FAQs:

• Which is better, ETFs or mutual funds? There is no universally better choice between ETFs and mutual funds. The optimal investment vehicle depends on individual factors, such as investment goals, risk tolerance, and tax considerations.
• How do I choose the right ETF or mutual fund? Consider your investment objectives, risk tolerance, financial situation, and time horizon when making this decision. It's recommended to consult with a financial advisor to determine the most suitable investment options.
• What are the risks associated with ETFs and mutual funds? ETFs and mutual funds are subject to market risks, including price fluctuations, interest rate changes, and economic downturns. ETFs also carry risks specific to their structure, such as tracking error and liquidity concerns.
• How do I invest in ETFs or mutual funds? You can invest in ETFs or mutual funds through a brokerage account or directly through the fund company itself. Research the available options to find platforms that align with your trading preferences and investment strategies.