7 Differences Between Mutual Funds and ETFs

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  Exchange-traded funds (ETFs) have been gaining popularity in the past few years. However, mutual funds are still the cornerstone investment of many retirement plans. Although there are many differences between the two investment vehicles, they are similar in that both can invest in a wide variety of asset classes and be actively or passively managed. Which is a better investment product for your portfolio? Discover seven key differences in this slideshow.

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  According to Investopedia, mutual funds and ETFs are defined as follows. A mutual fund is a diversified basket of securities that are professionally managed. Investors pool their money together and their share is invested on a prorated basis across the fund’s holdings. An ETF is a marketable security that tracks an index or a basket of assets, similar to an index fund, and trades like a common stock on a stock exchange.

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  #1 Trading Method
  A major difference between the two products is how they trade. ETFs trade during the day and are listed on an exchange, similar to a stock, whereas mutual funds trade only at the end of each day when the market closes. The price of those shares is then determined by its closing net asset value (NAV). Therefore, ETFs can provide more flexibility for investors who wish to do more trading, while mutual funds often better suit investors with a buy-and-hold strategy.

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  #2 Active or Passive Management
  Both mutual funds and ETFs can have a passive or active management structure. Passive management, also known as an index tracking strategy, is where the fund aims to closely track a popular index. Mutual funds are more likely to have active management with a portfolio manager who seeks to outperform a benchmark index or peer group average.

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  #3 Operating Expenses
  Because mutual funds are actively managed, they incur operating expenses that ETFs don’t have, and usually charge a higher expense ratio. The largest component of a mutual fund’s operating expenses is the fee paid to the investment advisor plus costs for recordkeeping, custodial services, marketing and more.

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  #4 Investment Minimums
  Most mutual funds require a minimum initial investment, ranging from $500 to $3,000, depending on the firm. This can be a barrier for beginning investors, or individuals with small sums of money to invest. On the other hand, ETFs can be purchased for the price of a single share – anywhere from a few cents to a few hundred dollars.

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  #5 Tax Efficiency
  Investors have no control over when a mutual fund pays a distribution of capital gains or when the fund sells securities in its portfolio, which is a taxable event for the shareholder. With an ETF, the individual investor controls the buying and selling of their shares. When selling for a profit or loss, that would trigger a taxable event.

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  #6 Sales Load
  Some classes of mutual fund shares assess a sales load, either during the purchase or the sale of the shares. Sales loads are a commission to an intermediary for distributing the shares of the mutual fund. ETFs can also have commission fees for trading.

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  #7 Liquidity
  Because ETFs trade throughout the day, they are easier to buy and sell. Selling mutual fund shares can be more of a challenge since the NAV is calculated only once per day, potentially restricting the ability to sell until the following day the market is open. Oftentimes there can be a penalty for selling shares shortly after they are purchased. However, with both products, liquidity can vary depending on the underlying composition of the portfolio.

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  Why Choose One Over the Other?
  Why choose one product over the other? This depends on your financial goals and investment style. If you are a long-term, buy-and-hold investor with little interest in trading, a mutual fund could be a good option. If you prefer to buy and sell more frequently, ETFs could be the better choice due to greater tradability, tax efficiency and lower fees. Ultimately, both products can offer investors a diversified portfolio of securities.

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  Which investment product is suited for you – mutual funds or ETFs? U.S. Global Investors provides investors with access to both. Learn more about our different funds today!