Investing in fund rather than individual stocks could be one of the wisest decisions you make, particularly if you’re looking to make money for retirement or for other long-term reasons. But before you throw your money into the market, you need to understand the differences between mutual funds vs. ETFs. Both types of funds can be smart and profitable investments, but they are distinct enough that one is often better than the other.
Not sure which is which? Read on for a detailed breakdown of both mutual funds and ETFs, as well as what distinguishes them.
What is a Mutual Fund?
A mutual fund is a collection of financial assets, like stocks and bonds, that investors put their money into collectively. For example, a mutual fund might be comprised of five different stocks from separate companies.
Rather than purchasing a stock from each company, a mutual fund investor can purchase a share in the mutual fund itself. The mutual fund’s value is derived from the value of all of its net assets (everything included in the fund itself).
By purchasing a share in the mutual fund, the investor diversifies their investments and protects themselves from risk.
What is an ETF?
An ETF or exchange-traded fund is similar to a mutual fund. It’s also a collective fund that includes many different financial assets or investment vehicles. However, ETFs are more recent and only launched in 1993, whereas mutual funds have been around for nearly 100 years.
Major Differences Between Mutual Funds and ETFs
Now that you know the basics of mutual funds and ETFs, let’s break down their key differences.
Management Style
Firstly, mutual funds are usually actively managed. They have one or more financial officers who:
- Regularly analyze the assets that make up the mutual fund
- Make decisions about what assets to include or remove from the fund
- Monitor the fund’s health
The active managers of mutual funds work on behalf of their clients or the fund’s investors.
ETFs, on the other hand, are either passively managed (i.e., there isn’t a financial officer watching the fund and its health) or are traded by individual investors.
That said, modern mutual funds and ETFs alike have swapped their positions somewhat. There are now more passively managed index mutual funds, which broadly track the performance of the market using things like the S&P 500. At the same time, many modern ETFs are actively managed by dedicated financial officers.
Mutual Fund Purchasing Limitations
Another big difference between mutual funds and ETFs is that mutual funds can only be traded or purchased once per day, at the end of trading hours. In contrast, ETFs can be purchased, sold, and traded just like stocks whenever regular market hours are open.
Therefore, individual investors can buy and sell ETFs whenever they like. But you can only place an order to purchase a mutual fund share or sell your shares once per market day. ETF values tend to fluctuate more because of this, so they are more “volatile.”
Fees
There are some differences in terms of fees, too. Mutual funds don’t levy any trading commissions, but they might have other fees or operating expenses. These usually go to pay the financial officers in charge of actively managing them. They include early redemption fees, withdrawal fees, etc.
ETFs have both explicit and implicit costs. Most ETFs operate with an expense ratio, as well as trading commission fees (so you pay your broker a little bit each time you make a trade). ETFs are oftentimes more expensive than mutual funds, but not always. Portfolio analyzers such as Personal Fund can detect hidden fees among both ETFs and mutual funds. That’s why a portfolio analyzer is an important tool in the repertoire of any investor.
Minimum Investments
Lastly, mutual funds usually have a flat dollar amount for their minimum investments. Because of this, investors can purchase fractional shares or complete shares in mutual funds.
ETFs are the opposite. They don’t often require minimum initial investments. But they also don’t allow investors to purchase fractional shares. Instead, you have to purchase whole shares just like you would with a regular stock or investment asset.
Since ETFs don’t have minimum investments, they are oftentimes considered more accessible compared to mutual funds. Mutual funds are better for large investments, such as saving for retirement or for growing a larger portfolio over time.
As you can see, both mutual funds and ETFs can be good investments. But mutual funds might be wiser if you are looking for “set and forget” financial security or gains, whereas ETFs could be better if you want to actively trade them yourself or if you want to get started investing with a very small amount of cash. Consider your options carefully, and use a portfolio analyzer tool like Personal Fund to make the best decision for your financial future!
