6 min read
ETFs vs. Mutual Funds: What makes them different
-
-
Copied link to Clipboard!
If you’re looking to invest in the stock market, you might be thinking about investing in a mutual fund. But exchange-traded funds (ETFs) have become a popular alternative in recent years. They have many of the same benefits as mutual funds but are usually less expensive than mutual funds. Both options come with their fair share of pros and cons. If you’re not sure which is right for you, use this guide to get started.
LESSON CONTENTS
What is a mutual fund?
A mutual fund invests your money across a number of different stocks, bonds and other assets, which reduces the risks associated with investing in an individual asset.
Mutual funds are usually actively managed. This means that a fund manager actively trades investments within the fund and tries to select investments to outperform its benchmark. There are two types of mutual funds, open-ended and closed-end funds. Open-ended funds are the more common of the two. With these types of funds, new shares are issued as more people buy into the fund. The price of the mutual fund is determined at the end of each day and is called the net asset value (NAV).
What is an ETF?
An ETF works like a mutual fund in that you spread your money across different investments, thus reducing the risk. Most ETFs are passively managed, with their investments tracking an underlying subset of the market, also known as an index.
Like individual stocks traded on the stock exchange, ETFs have a share price that is determined by a number of factors, including market demand and the underlying value of the assets in the fund.
ETF vs. Mutual Fund
Management styles
One of the main differences between ETFs and mutual funds is their management styles. Typically, mutual funds are associated with active management and ETFs with passive management. Active management may be more appropriate for certain asset classes or if you want your investments to try to adapt with changing market conditions. Passive management may be more appropriate if you’re looking to be more hands-off and let your investments sit and weather market fluctuations over a long period of time.
While there are many thoughts on the debate of active versus passive management, it’s important to find an investment strategy that is suited for your specific goals and needs.
Management costs
You should also consider the costs associated with managing your investments, commonly known as expense ratios. Actively managed funds that have professional asset management usually have higher expense ratios than passively managed funds. These expense ratios are used to pay for fund management, administrative expenses and other costs.
Some mutual funds have discounts known as breakpoints. This means that your expense ratio may be reduced if you invest larger amounts of money. Mutual funds may also come with sales charges and other commissions when you buy or sell your shares of the fund, so be sure to check to see what requirements and fees are associated with the fund before you invest.
Trading patterns
The other major difference between ETFs vs. mutual funds is how they’re traded. ETFs, as the name implies, are traded on an exchange. This means that shares of the ETF can be traded throughout the day (during trading hours) and in real time. Share prices of the ETF may be directly impacted by supply and demand. For example, if many people sell their shares of a particular ETF, that ETF may be seen as less valuable, and its share price may drop as a result.
On the other hand, open-ended mutual funds buy and sell shares in a direct transaction between the investor and the fund company. Unlike ETFs sold on an exchange, when an order is placed to buy or sell shares of a mutual fund, the fund company waits until the end of the day when the NAV is determined, then places the trade.
Capital gains tax
These two options also differ in terms of the way they are taxed. ETFs tend to be more tax-efficient than mutual funds. The investor usually doesn’t have to pay a capital gains tax unless the shares are sold for profit.
Actively managed mutual funds can incur capital gains tax due to the way they are structured. The fund manager may buy or sell investments within the fund. When investments are sold for a gain, the capital gains tax will be passed on to everyone who owns shares of the fund, even if you never sold your shares.
Entry minimums
Funds may require you to invest a certain amount of money to get started. Some mutual funds may have investment minimums that can range from hundreds of dollars for beginner funds, to tens of thousands of dollars for more advanced funds. There are some mutual funds that don’t require a minimum investment. However, they may have other requirements like holding the fund for a certain period of time. If you sell your shares before then you may be charged a fee.
ETFs may be more accessible because you can buy them on an exchange with the minimum amount being the cost of one share. Some investment brokerages allow you to trade fractional shares, which means you may not even need the total cost of one share to invest in the ETF.
Risk tolerance
EFTs are subject to market volatility because they are bought and sold on stock exchanges like the S&P 500 and Dow Jones Industrial Average. These exchanges will rise and fall based on investor confidence and changing economic conditions. However, the market generally grows over the long term, so if the investor is willing to wait out downturns in the short-term, the EFT will generally make a profit in the long run.
Mutual funds expose investors to less risk because they are actively managed. The fund manager will buy and sell securities based on broad market trends and in-depth analysis.
Which is right for you?
There are lots of different factors to consider when signing up for an ETF or mutual fund. Consider your investment goals and investment timeline before investing in a fund or asset. If you’re looking for something that tries to adapt to and outperform the benchmark, an actively managed mutual fund may be a suitable choice. If you want to match the performance of an index for lower costs, an ETF may be more suitable.
For more information on investment products and how they can help you achieve your financial goals, talk with one of our LPL Financial Advisors1 and Ent Credit Union.
PLEASE NOTE: The information provided is for educational purposes only and should not be considered recommendations or advice. Please consult the appropriate financial, tax or legal professional to determine whether the strategies presented in this article are appropriate for your situation.
1Securities and advisory services are offered through LPL Financial (LPL), a registered investment advisor and broker-dealer (member FINRA/SIPC). Insurance products are offered through LPL or its licensed affiliates. Ent Credit Union are not registered as a broker-dealer or investment advisor. Registered representatives of LPL offer products and services using Ent Credit Union, and may also be employees of Ent Credit Union. These products and services are being offered through LPL or its affiliates, which are separate entities from, and not affiliates of, Ent Credit Union. Securities and insurance offered through LPL or its affiliates are:
Not Insured by NCUA or any Other Government Agency | Not Credit Union Guaranteed | Not Credit Union Deposits or Obligations | May Lose Value
Ent Credit Union (“Financial Institution”) provides referrals to financial professionals of LPL Financial LLC (“LPL”) pursuant to an agreement that allows LPL to pay the Financial Institution for these referrals. This creates an incentive for the Financial Institution to make these referrals, resulting in a conflict of interest. The Financial Institution is not a current client of LPL for advisory services. Please visit https://www.lpl.com/disclosures/is-lpl-relationship-disclosure.html for more detailed information.
The LPL Financial registered representative(s) associated with this website may discuss and/or transact business only with residents of the states in which they are properly registered or licensed. No offers may be made or accepted from any resident of any other state.
Check the background of the investment professionals associated with this site on FINRA’s BrokerCheck.
Related Resources
View All
8 min read
Are CDs Good For Retirement? What You Need to Know About Retirement CDs
When planning for retirement, it’s crucial to diversify your savings to balance risk and ensure steady growth. One popular savings option that has gained attention over the past year is the Certificate of Deposit (CD). So, are CDs good for retirement? Let’s learn more. This guide will explore whether retirement CDs are a good option for your retirement savings and how to incorporate them into your retirement planning.
12 min read
Retirement Planning Guide: Why Retirement Planning is Important and How to Get Started
As we age, ensuring that we have enough resources to sustain our desired lifestyle becomes increasingly critical. Thus, understanding why retirement planning is essential is the first step toward securing your future. Without a solid plan, you might face financial challenges during retirement, such as inadequate savings, high medical expenses, and an inability to cover basic living costs. On the other hand, by planning ahead, you can enjoy your retirement years without worrying about financial uncertainties.
With a solid retirement plan, you can achieve your dreams and maintain your desired lifestyle. Start with this retirement planning guide to learn how to navigate the complexities of saving and investing for the future.
12 min read
Refinancing Your Mortgage Loan as a Retirement Strategy: Is It Right for You?
As retirement approaches, financial stability becomes a paramount concern. Like many other Americans, your home is not only a place of comfort but might also be the largest asset or liability in your portfolio. Refinancing your mortgage is a common strategic move to enhance your financial situation as you transition into retirement. This guide will explore how to use refinancing effectively as part of a comprehensive mortgage and retirement planning strategy.
15 min read
Should You Pay Off Your Mortgage Before Retirement? Pros and Cons
As retirement approaches, many homeowners begin to consider their financial landscape, particularly their mortgage—their most significant monthly expense. Often, the dilemma is: should I pay off my mortgage before I retire? Effective management of your mortgage loan situation as you near retirement is crucial. Making the correct choice will ensure financial stability and reduce stress in your later years. Deciding whether to pay off your mortgage before retirement or continue with regular payments should be on your retirement planning checklist.
8 min read
What is an IRA and Should I Invest in One?
If you’re getting ready to save for retirement, you may be thinking of opening what’s known as an Individual Retirement Account (IRA). This is a common retirement savings tool to help you make the most of your hard-earned money. There are many different types of IRAs to choose from. Making the right choice all depends on your finances and future plans for your savings.
Retirement plan checklist
Retirement planning can be a complex task that requires careful consideration to ensure you have enough funds to maintain a comfortable lifestyle during your golden years.
8 min read
Calculating Retirement: How Much Money Do I Need to Retire?
Saving for retirement is an almost universal problem. At some point, and at some age, most people aren’t physically able to keep working. And it’s why setting aside a nest egg is crucial. The idea of running out of money when you’re no longer able to work can be frightening to many people. Social Security is designed to fill in the gaps, not be the sole source of retirement income. Most people can’t afford to live just on their monthly Social Security benefits. That’s why you need to do your research before deciding how much to save for your retirement each month. You might also be able to use a retirement savings account to reduce your income tax at the end of the year. Use this in-depth guide to make sure you can cover your everyday expenses when going to work is no longer an option.
6 min read
ETFs vs. Mutual Funds: What makes them different
If you’re looking to invest in the stock market, you might be thinking about investing in a mutual fund. But exchange-traded funds (ETFs) have become a popular alternative in recent years. They have many of the same benefits as mutual funds but are usually less expensive than mutual funds. Both options come with their fair share of pros and cons. If you’re not sure which is right for you, use this guide to get started.
4 min read
What ESG Investors Should Know About Greenwashing
Investors want to know that the companies they support share their commitment to certain ideals. But judging a company based on these values can prove difficult. ESG investors can easily fall prey to what’s known as greenwashing, which is when a company deceives the investor into believing they are committed to certain causes and ideals. Learn more about the relationship between ESG investing and greenwashing, so you protect yourself from misleading claims.
5 min read
NFTs: What is NFT (Non-Fungible Token)?
There’s a new type of digital commodity on the market. NFTs have been gaining a lot of notoriety among traders, investors, and collectors. So, what are NFTs, and why are they causing such a fuss? Learn more about these unique digital assets and why they’re being called the future of trading.
6 min read
What You Should Know Before Taking a Loan from Your 401(k)
Your 401(k) is your retirement nest egg. You’ll need that money later in life once you have stopped working. If you need extra cash for an emergency or have trouble making ends meet, you may be tempted to tap into your 401(k) before retiring. After all, it’s your money. But withdrawing from your account before you retire may leave you with less money for your golden years. Keep these tips in mind when tapping into your 401(k).
7 min read
How to Buy Stocks for the First Time: Know the Basics
You’ve heard about people buying stocks. You’ve even heard about people making a fortune by picking stocks. That sounds great! How do you get in on that? Not so fast. Buying stocks, even for the first time, is straightforward. Making a fortune on them can be harder, but it’s possible to get a nice rate of return without taking on unnecessary risk.