Exchange-traded funds (EFTs) and mutual funds are very similar types of funds, but being aware of their nuances is important to investors of any experience level.
Similarities between EFTs and Mutual Funds
The most important thing to know is that EFTs and mutual funds are both professionally managed from “baskets” or “pools” of other stocks or bonds. Overall, this takes away the time and effort from managing your investments, though there are differences in management styles that will be discussed later.
EFTs and mutual funds offer diversification to your investment portfolio by providing domestic and international stock and bond options as well as a variety of asset classes and niche markets. Diversification can lessen the potential for loss in investments, making these funds a popular choice.
Differences between EFTs and Mutual Funds
Management styles: Funds that are actively managed are handled directly by professional managers who buy or sell to try to beat the market; this can bring greater profit to the investor, but does come at a higher cost than passively managed funds. Mutual funds are mostly actively managed. Passively managed funds typically rely on pre-selected market indexes like the S&P 500 or the Nasdaq 100 to determine which funds are bought and sold. EFTs are almost always passively managed, and while actively managed EFTs are available, they often have much higher rates.
Trading styles: EFTs are purchased on a stock exchange which changes throughout the day, so your purchasing price may vary from that of other investors. Mutual funds are priced and traded at the end of each trading day, meaning you pay the same as every other investor.
Minimum investment: Mutual funds offer a flat investment deposit that is often pretty pricey. EFTs, on the other hand, can be bought for the price of just one share.
Taxing: EFTs are typically more tax-efficient, as they often realize fewer capital gains. Mutual funds typically incur higher capital gains -- these are passed on to all the shareholders regardless of whether or not their loss has been realized.
Types of ETFs and Mutual Funds
It should also be noted that there are different classifications of EFTs and mutual funds. For EFTs, there are three classifications:
Exchange-Traded Open-End Index Mutual Fund
Exchange-Traded Unit Investment Trust (UIT)
Exchange-Traded Grantor Trust
You can read more about EFTs here.
For mutual funds, the classifications are open-ended and closed-end funds. Open-ended mutual funds offer unlimited shares, whereas closed-end funds issue a set number of shares.
There are many considerations to be made when choosing which type of fund to invest in, and though the two are similar in some ways, their effectiveness for you personally will depend on what type of investment portfolio you are willing and able to build.
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