ETFs vs mutual funds: what's the difference?
If you're looking to invest your money, you might be wondering where to put it. Should you invest in ETFs or mutual funds? Although these two types of investments have a lot in common, there are some fundamental differences that you should be aware of.
Here, we're going to examine each type of investment, explain how they work, and highlight the differences between ETFs and mutual funds.
What is an ETF?
An ETF, or exchange-traded fund, is a type of investment fund that trades on an exchange like a stock. An ETF is made up of a basket of stocks or other assets, like bonds or commodities. When you invest in an ETF, you're purchasing a share of that basket of assets.
ETFs are popular because they can provide diversification. Rather than investing in just one stock, you're invested in a variety of stocks. That can help reduce your risk compared to investing in a single stock.
ETFs are also transparent, meaning that their holdings are disclosed daily. This makes it easy to know exactly what you're investing in. ETFs can also have low expense ratios, which means that they are less expensive to own than many mutual funds.
What is a mutual fund?
A mutual fund is also an investment fund, but it operates a bit differently than an ETF. Mutual funds are made up of a pool of money from many investors. That pool of money is then invested by a professional fund manager who selects the stocks, bonds, or other assets held in the fund.
When you invest in a mutual fund, you're purchasing a share of the overall fund. The value of your investment rises or falls based on the performance of the underlying assets held in the fund. Because you're investing in a pool of assets, mutual funds provide diversification, which can help reduce risk.
One of the benefits of mutual funds is that they can be actively managed. That means that the fund manager can adjust the holdings in the fund as market conditions change. This can potentially increase returns and reduce risk.
What are the differences between ETFs and mutual funds?
Although ETFs and mutual funds share some similarities, there are also some key differences between the two.
Trading
ETFs can be bought and sold throughout the trading day just like stocks. Mutual funds, on the other hand, are priced at the end of the trading day, after the market has closed. This means that mutual fund trades are executed based on the end-of-day price.
Expenses
ETFs tend to have lower expense ratios than mutual funds. That's partially because ETFs don't have expense ratios associated with each individual holding in the fund. Mutual funds, on the other hand, have higher expenses because they have to cover the costs of managing the fund.
Taxes
Because ETFs are traded like stocks, they tend to be more tax-efficient than mutual funds. This is because mutual funds are required to distribute capital gains to shareholders every year, which can trigger taxes for those investors. ETFs, on the other hand, are structured in a way that can help minimize capital gains taxes.
Minimum Investment
ETFs can be purchased for the price of a single share, which can be as little as a few dollars. Mutual funds, on the other hand, often require a minimum investment amount, which can range from several hundred to several thousand dollars.
Which is right for you?
Deciding whether to invest in an ETF or a mutual fund is ultimately a personal decision. It depends on your investment goals, your risk tolerance, and your investing style.
If you're looking for an investment that provides diversification and has low expenses, an ETF might be a good choice. If you prefer to have a professional fund manager make investment decisions for you, then a mutual fund might be a better fit.
It's also worth considering how often you plan to make trades. If you're the type of investor who likes to buy and sell frequently, then an ETF might be more suitable. If you prefer a more hands-off approach to investing, then a mutual fund might be a better choice.
Ultimately, the key is to do your research, understand the differences between these two types of investments, and choose the one that aligns best with your investment goals. Whether you choose an ETF or a mutual fund, the most important thing is to start investing today. Investing early and regularly can help you achieve your financial goals and build long-term wealth.