Have you thought of ETFs vs. mutual funds?

While most investors are familiar with mutual funds, many do not know as much about ETFs. They have certain advantages, and investors should consider ETFs vs. mutual funds when deciding on their portfolios.

While a mutual fund can simply be looked at as a pool of investor money that is professionally managed and invested in various instruments such as stocks and bonds, an ETF works differently. An ETF, or exchange-traded fund, is designed to track an index but not outperform it. The index can be anything from the S&P 500 to a commodity, and its value usually follows the value of what it is designed to track very closely.

What really separates them vs. mutual funds is the fact that they can be traded like a stock. This is because ETF are not opened-ended. This means they have a fixed number of shares. On the other hand, a mutual fund’s investment is open-ended and does not have a fixed number of shares. Shares purchased in them simply go to increase the pool of money available for investment by the fund.

Advantages of mutual funds

The main advantage of mutual funds is that they have 24/7 management. Since an ETF just tracks an index, it will follow that index down when it declines. With professional management, mutual funds can increase or decrease market exposure depending on the conditions. This means a good mutual fund can significantly outperform a market (although they can certainly under perform too).

Mutual funds also offer various features such as opportunities to transfer funds between families, reinvestment of dividends and easy monthly purchases. Since ETFs are bought and sold like stocks, one must place an order when purchasing them just like they would do with a stock.

Furthermore, unlike ETFs, there is no commission or spread why buying or selling no-load mutual funds direct. Thus, with smaller and short term investments, mutual funds can actually be cheaper

Advantages of ETFs

ETFs do have a number of advantages vs. mutual funds. Since they do not have professional managers taking care of them all the time (much of their maintenance is done with computers), their operating costs are much lower. This makes their fees lower than even no-load mutual funds.

While some people mistakenly believe that ETFs do not create taxable events unless they are sold, this is not the case. However, they are far less likely to create the types of taxable events that will bring the government knocking than mutual funds do.

Since ETFs can be bought and sold like stocks, they are much easier to trade. With the advent of cheap, online trading in recent years, they can be economically purchased even in low quantities.

Unlike mutual funds that cannot be bought and sold quickly, the nature of ETFs makes them very liquid, and it is possible for alert investors to bail out of the market quickly when it is heading south.

Finally, ETFs can be purchased in small quantities and do not have the minimum investment requirements many mutual funds do.

Types of ETFs

ETFs have expanded rapidly and now cover just about every type of investment from commodities and derivatives to currency trading.

The final analysis

The final analysis as to which is better depends on the investor. The simplicity and constant management mutual fund investments offer make them a good choice for less experienced investors looking for diversification. Moreover, investing in mutual funds can be cheaper in some situations.

On the other hand, the lower costs, ability to sell quickly and flexibility of ETFs makes them increasingly popular with more experienced investors. However, less experienced investors can certainly purchase ETFs and more established investors often want the services mutual funds offer. Therefore, the type of investments one wants is likely to be the top determining factor when deciding on ETFs vs. mutual funds.

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