The world of securities goes far beyond stocks and bonds—there are several different variants within those broad categories. Two other popular investment vehicles are Exchange Traded Funds, more commonly known as ETFs, and mutual funds. Many people invest in both ETFs and mutual funds as part of a balanced investment portfolio. So what’s the difference between the two?
Read on for an in-depth discussion of ETFs and mutual funds, along with why you might want to choose one over the other.
What is an ETF?
Similar to stocks, ETFs trade on an exchange. They can be bought or sold daily. The investments within an ETF could include stocks, bonds, or commodities. Some ETFs track market indexes like the S&P 500 while others might track investments such as Gold, industries like banking and technology, and even socially responsible investing.
ETFs are a great way for investors to diversify their portfolios. Instead of buying one share of a single stock, investors can purchase one share of an ETF, which grants them access to a diversified basket of securities.
ETF prices fluctuate as shares are bought and sold on an exchange. They’re often seen as a more affordable option for investors since commissions and fund operation costs are often significantly lower than mutual funds.
Because most ETFs are designed to track a particular asset, index, or commodity, they can often be managed passively, thus reducing management costs.
What is a Mutual Fund?
Similar to an ETF, a mutual fund is a basket of securities that helps investors diversify their portfolios. One key difference is that mutual funds trade once per day when the markets close at a set price, instead of being available for trading during the day when the price could fluctuate.
Over half of all mutual funds are actively managed. This means that rather than passively tracking a particular asset or index, financial professionals try to maximize the fund’s return by actively buying and selling securities. This results in higher associated costs that include management, trading, operation, and marketing fees.
Many mutual funds have minimum investment requirements. Some are as low as a few thousand dollars while others can be as high as one million dollars.
Key Differences Between an ETF and a Mutual Fund
- Liquidity. ETFs trade during market hours like stocks. Mutual funds are redeemed once per day after the market closes.
- Tax Efficiency. ETFs are often more tax-efficient than mutual funds.
Which One is Best for You?
There’s no one-size-fits-all investment strategy, and every investor’s portfolio will look a little different. How you allocate your investments should be based on your goals, time horizon, risk preferences, tax situation, and a variety of other factors.
Luckily, you don’t have to choose between ETFs and mutual funds. Many investors can benefit from strategically purchasing both ETFs and mutual funds depending on their needs. Investing in both ETFs and mutual funds can help you to further diversify your portfolio and integrate passive and active investment management.
Take a closer look at how your goals can drive your investment plan with our interactive investment tool.
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