Exchange-traded funds (ETFs) and mutual funds are similar at a glance. They are both ‘baskets’ or ‘collections’ of individual securities that are bought and sold as a package, while both have gained popularity in large part because of their diversification benefits.
Mutual funds and ETFs are, however, different in some key ways that investors need to be aware of when building their portfolios. Here, we’ll take a look at the differences between ETFs and mutual funds and why investors might choose one over the other.
What are the differences between ETFs and mutual funds?
Here are the key differences between ETFs and mutual funds:
How they’re traded
One of the clearest points of difference between ETFs and mutual funds is how (and when) they are traded. Like stocks, ETFs can be traded intraday, meaning their price goes up and down over a given day and they can be bought and sold at any time if the market is open.
Mutual funds, on the other hand, are traded once per day and all investors trading on that day receive the same price. This is based on a calculation known as the net asset value. This, arguably, means that mutual funds are less flexible than ETFs.
Management
Another key difference is the degree to which each fund is managed. While they can be both actively and passively managed, most ETFs are passive investments that are pegged to indexes. That is to say that they try to reflect the performance of a particular index.
Mutual funds are also both active and passive, but the majority are actively managed. This means that fund managers made active decisions about what to include in the funds. This is a distinction that has been blurred in recent years, so it’s worth investors checking before making any decisions.
Fees
Generally speaking, actively managed mutual funds tend to come with higher fees and higher expense ratios than ETFs. This is simply the cost of active management. ETFs do have fees of their own, but they are relatively minor and are a result of being bought and sold like stocks.
Of course, with actively managed ETFs growing in popularity and passive index funds making up a large part of some mutual funds, this distinction is less reliable. It’s always worth researching fees before making any decisions on ETFs vs mutual funds.
Summary
There are some other minor differences between ETFs and mutual funds, like minimum investments, but these will differ from fund to fund. Both, however, represent relatively low-risk investments when compared to investing in an individual stock or bond.
For investors, an ETF may be more suitable if you are looking for a lower minimum investment and you want greater control over the price of your trade. In terms of risk, the difference comes more from the underlying holdings than it does from the structure of the investment.
If you want to find out more about ETFs and see how you could make them part of your long-term financial planning, check out our extensive range of options and the powerful tools we’ve built for our customers.
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