The number of exchange-traded funds (ETFs) has skyrocketed in recent years.
These index funds offer a basket of stocks and can be bought and sold throughout the day in much the same way as trading individual stocks.
Mutual funds, also known as open-end fund companies, pool money from many investors to purchase a basket of securities such as bonds or stocks.
Individual investors deposit their cash in mutual funds for periods ranging from months to decades under an arrangement known as dollar-cost averaging.
A Mutual fund is an investment vehicle made up of a basket of assets organized into one portfolio.
The basket consists of different financial instruments such as stocks, bonds or other assets.
The assets are purchased by the management team of the mutual fund company through different types of investment banking services.
Mutual funds are usually run by an asset management company (AMC). These companies invest money on behalf of their clients who subscribe to these funds.
An AMC is typically paid a fee for its services in the form of an annual fee known as an expense ratio included in the total expenses charged to investors each year.
Shares in a mutual fund represent an investor’s stake in the assets making up the portfolio as a whole.
These assets determine the fund’s NAV (net asset value) at any given time after subtracting liabilities and reserves required by law or prudence—for example, unrealized gains or losses, taxes, and deferred charges.
The mutual fund portfolio is designed and maintained to match the fund’s investment objective.
3 Primary differences
- The primary difference between a Mutual Fund vs an ETF is that an ETF trades on exchanges just like stocks do, whereas a mutual fund trades at Net Asset Value (NAV).
- Another key difference is that an ETF may have creation/redemption baskets that affect how new units are distributed, while a Mutual Fund does not have this mechanism.
- The last big difference between these two types of investments is their fees – specifically for market access, management expenses, administrative charges, etc.
It is essential to understand these deductions as they will affect your performance over time.
You can find these deductions on a detailed list in a mutual fund or ETF description.
Essentially, a Mutual Fund will have a yearly fee for managing the cash flow and an additional fee for each transaction made internally.
Many Mutual Funds will also have a sales load typically around 5%. You must pay the sales load regardless of the investor getting out of the fund before their time frame ends. Over time, it does add up if you are constantly trading in and out of your funds.
ETFs usually do not have any internal transactions occurring inside them with how they are structured – instead, they simply track an index or asset class.
So at the end of every year, all that needs to occur is you pay a small annual fee for management expenses and an additional fee for market access. H
owever, to offset this, you will pay a small transaction fee each time you purchase or sell the ETF. These fees typically average around $10-$15 per trade, far less than most Mutual Funds.
Mutual funds are generally more flexible in terms of withdrawal options because they can allow investors to withdraw money at any time during the trading day, while many financial institutions do not permit this.
Withdrawals from an ETF often require a request by email, which you must submit before 4:00 pm ET on specific dates.
This type of limitation is usually found with no-load mutual funds, but some companies offer different conditional redemption policies depending on the size of the investment or account holder status.
The biggest drawback
Some people recommend getting into ETFs over mutual funds because you usually pay less in fees when doing an internal transaction between families inside the same fund company.
However, there are many other factors to look at internally for this statement to hold – including that your money will be used frequently compared to another similar fund offered inside the same family.