Exchange-Traded Funds vs Mutual Funds: Which is Better?
When it comes to investments in stocks, bonds, and other instruments and securities, exchange-traded funds (ETF) and mutual funds are two funds that very often bother the minds of investors as they seek the best investment solution for short and long term investment goals. While EFT and mutual funds are similar in a lot of ways – such as how they both offer diversification in assets, there are still some significant discrepancies between the two funds – and these are seen in ways each of them are managed. For instance, a typical ETF can be traded at the exchange market (bought or sold) at any time of the day much like stocks, but the same can not be said for mutual funds which are only open to be bought when trading has ended for the day and price calculated.
Another remarkable difference in these funds is that when you invest in mutual funds, you must become very active in its management and decision-making to know how and when to allocate the fund’s assets. But, an ETF holder may not necessarily need to be as active because of the nature of the fund, and how to specialize in is to a given market index.
Whether you hold a fund under ETF or with mutual funds, both of them offer optimum investment opportunities to the investor and require shrewd research to decide which one of the funds best suits your investment plans. That is why in this article, we will expertly define the two funds stating their differences and similarities to help you decide which is a better investment plan than the other.
Table of Contents
What Are Mutual Funds?
Mutual funds are Securities and Exchange Commission (SEC) certified investment company that has the responsibility of bringing together (pooling resources) funds from several investors to create a joint investment in either bond, stocks, commodities, and so on. When investors acquire shares under mutual funds, they automatically enjoy ownership of the particular share they bought, each, and they also qualify to benefit from the revenue it may generate.
How Do Mutual Funds Work?
Mutual funds become fully operative after investors buy portions of shares from the fund, pool them together, and invest them in either stock, bonds, or other securities. Typically, these funds can be purchased by investment bankers such as a broker, or directly from the fund itself. A combination of assets and instruments owned by investors in the mutual fund becomes the portfolio of which the Securities and Exchange Commission (SEC) regulates and manages. Through regulations, mutual funds are often mandated to have access to their shares and price them once every working day, usually at the close of a stock exchange for the day. So, consequently, the funds’ liabilities minus the per-share price value of the funds bring about the fund’s Net Asset Value (NAV) – to which all mutual funds are to sell and reclaim shares. By this implication, mutual funds investors typically are unaware of the purchase price and will only know so after the calculation of the next NAV.
What Are The Major Kinds Of Mutual Funds?
Generally, mutual funds are known to come with seemingly improved minimum investment demands compared to the ETFs, and these minimum investment demands are usually influenced by the fund or the company to which they are owned. Mutual funds are mainly of legal types – open-ended funds and closed-ended funds – and are mostly managed by an expert team consisting of professionals within the fund, or by outsourcing functions to a certified fund manager.
1. Open-Ended Mutual Funds
Open-ended mutual funds are the kind of funds that are found very common and proliferated in large amounts in assets in the securities marketplace. Under this kind of fund, buying and selling of shares often involve fund investors directly dealing with the fund company, and most times, shares to be issued here are unlimited and endless. So, what this means is that the more the investors come around for a fund purchase, the more the company slips out shares to them. However, through a procedure called ‘Marking to Market’, government regulations can check and control the activities under this type of mutual funds daily. Marking to market typically works to set and reset the per-share price of the funds to match the value of the assets that are obtainable in the portfolio. For open-ended mutual funds, the worth of an individual investor’s shares is not all that affected by the number of shares that are outstanding.
2. Closed-Ended Mutual Funds
Closed-ended mutual funds are mutual funds which, by their very nature, are in the habit of issuing a very limited amount of shares, typically issuing only a small amount of shares, and do not increase its available shares even when there is a high demand for shares by fund investors. The prices of Closed-ended mutual funds are determined by investors’ demands and are not usually influenced or dictated by the NAV (Net Asset Value), of the given fund, and purchasing of shares from this kind of funds would require investors at a premium, or on the NAV discount list.
Exchange-Traded Funds (ETFs)
Unlike most mutual funds which are relatively more expensive to acquire, exchange-traded funds are a far less costly set of instruments for investors to consider, especially for investors at the entry or beginner level. Costs may typically range from the cost of the share itself (and could be a single share), the cost of mandated fees, and the cost of commissions. While mutual funds are always only redeemable one time at the close of the exchange market for the of a trading day, ETFs enjoy more flexibility in terms of it being able to be created in larger amounts by professional fund creators, and redeemable in equally large amounts, and are also able to access and trade on any time of the day the investor chooses to trade, just like how a typical stock is traded. ETFs can be short-term and allow for a variety of fund provisions that stakeholders find interesting and attractive. This draws them to want to price ETFs continuously in the open market, the outcome which often affords ETFs the ability to trade at a different price outside of the try pricing of NAV.
What Are The Similarities Between Mutual Funds and ETFs?
Examined below are some of the most important characteristics shared by mutual funds and ETFs. However, these common attributes they share might come as a plus or minus for different investors based on the nature of their investments – which is why investors should go for the one that has the features acceptable to them.
The importance similarities between mutual funds and ETFs
1. Fund Management
In terms of management of funds, typical ETFs and mutual funds often get managed by expert investment bankers, professional advisers, and securities brokers who are known to be registered under the Securities and Exchange Commission (SEC).
2. Instruments Diversification
As with some mutual funds, all ETFs allow investors to enjoy the benefit of diversifying their investments across a plethora of securities companies and industries. This goes forth to enable investors to avoid incurring too many risks in the event a particular company or industry encounters a problem.
3. Trading Convenience and Fund’s Liquidity
Investors who buy into ETFs naturally savor the flexibility of trading and redeeming their shares whenever time they want and however they choose to, provided they are doing so within the business day. They can also choose to trade multiple times a day before the exchange market closes for the day. ETFs investor only just needs a good device and an internet connection to access their portfolio. For mutual funds investors, redeeming their shares is mostly only possible over the calculation of the next NAV, coming with a minus on fees and commissions at the close of an exchange on a working day. But whenever the case is, any mutual funds or ETFs traded by a broker are mandated to be settled within two working days.
4. Required Minimum Investment
As has already been established before, ETFs do not necessarily involve potential investors breaking the bank to own a share as they accommodate and accept investors with a little number of dollars. The same may apply to mutual funds (some, not all mutual funds), which set a low rate for the number of dollars needed to own a share, allowing for a large number of investors to purchase and own funds.
5. Paid Fees and Commission
Whether it is an investor who owns a fund under ETFs or a shareholder with the mutual funds, there is usually a strict application of fees, charges, and commissions that are liable to be paid at one point or the other. For mutual funds investors, charges in annual fees, sales, and management among other things are some of the expenses they should look out for whether funds are at profit or incurring a loss. For ETFs shareholders, expenses accumulate from commissions in brokerage, management, and others, also, whether or not ETFs are performing well. Additionally too, taxes on capital gains are also an expensive route for both mutual funds and ETFs.
6. Control Of Assets And Securities
In terms of having control over what securities or instruments to be added in the funds’ portfolios, both mutual funds investors and ETFs shareholders do not have the liberty to decide or influence. This is mostly the decision of the underlying assets creator as well as other external factors and commissions, and so investors in both funds will have to sit out on that one.
7. Uncertainty In Pricing
As regards pricing, ETFs owners can access pricing in real-time, or at any given moment of choice, in a working day of an exchange market. They can do this by act of simply talking with their broker, or through direct access using a computer device, such as a smartphone, tablet, or laptop, and a good internet connection. Conversely to this, mutual funds owners purchasable and redeemable prices are a little bit rigid, and generally depend on the NAV of the certain funds, which may take time to calculate, and this is why it typically takes time for mutual funds owners to access their funds as often as ETF’s.
What Are The Factors To Consider Before Investing In Mutual Funds Or EFTs?
There are a lot of factors prospective investors might first consider and get right before they proceed with acquiring shares with either mutual funds, ETFs, or both. Some of the most important ones include:
1. Research and Find Out All You Can About The Mutual Funds and ETFs
Whether you want to purchase shares under ETFs or with mutual funds, investors must always strive to do a lot of research before they set out to invest. There is no such thing as wasting too much time researching, learning, and knowing the roots of the different funds because they are worth it. It is through researching and verification of information that you know the best fund that suits your preferences among the two and the one to put your money on. Some of the ways you can find out relevant information are through investment professionals, brokers, investment bankers et cetera. Reading prospectus and documents about mutual funds and ETFs can also help.
2. Define Your Financial Goals And Determine Risks
Another important consideration for investors whether of mutual funds or ETFs is that they define and determine, from the onset, their financial expectations and the number of risks they can let out. Check the investment strategies and compare if they meet your taste and recommendation, because any investment strategy that does not reverberate with you – whether in yes of the number of risks, timing, commissions, and fees, etc – is one to be avoided to prevent you encountering problems on the long run.
3. Weigh The Available Risks
Investors should also make it a habit of weighing the level of risks available in any one fund that draws their interest. For starters, it is always better, to begin with, low risks fund and then move up from there when you are savvier and experienced with investments. As with mutual funds and ETFs, risks can differ, but the general formula with both of them is; when the potential return is big, the risk becomes massive.
4. Know Your Sponsor’s Style of Investment
Before putting your hard-earned money on any of the funds, it is advisable to study and be acquainted with the mutual funds or ETF’s underlying sponsor, and master their style and philosophy of investment. This is very important to help you plan your strategy, as the performance of your later funds will be largely determined by the activities of the fund’s underlying sponsor.
Investopedia. “Mutual Fund vs. ETF: What’s the Difference?” https://www.investopedia.com/articles/exchangetradedfunds/08/etf-mutual-fund-difference.asp
Investor.gov. “Mutual Funds and ETFs – A Guide for Investors.”