A Comparison for Decision Makers
When you first run into the exchange-traded fund, it’s entirely possible to think that it might actually be a mutual fund with a fancy new name. While it’s true that there are a number of similarities between the two, the differences and their implications are huge.
As you continue to explore the way ETFs work — as you may have done in the previous three segments of this Wall Street Survivor series on the subject — the distinction between the two things may seem to overlap.
In this posting, we’ll pause to break out the differences. Our objective is that, after reading this article, you’ll eventually understand the pros and cons of ETFs and mutual funds and figure out which ones work best for your portfolio.
ETFs and mutual funds: The timing factor
Both ETFs and mutual funds collect a whole bunch of stocks and/or other securities into one portfolio. With each product (ETF of fund), you’re able to quickly diversify your stock holdings without having to invest a tremendous amount of time into research.
One basic difference between the exchange-traded fund and the mutual fund is that you can trade the ETF any time you like during the market day but you can trade a mutual fund only at the day’s end, when what’s called the net asset value has been calculated. This means that you can be fairly responsive with ETFs, while with mutual funds your hands are somewhat tied for quick decision-making.
ETFs and Mutual Funds: The Cost Factor
Another difference between the ETF and mutual funds has to do with how much it costs to maintain them. And for investors this matters because, as in so much of life, the market likes to pass its costs along to clients.
Different Operating Costs
Unlike a mutual fund, one of the things ETFs don’t involve is the need to actually invest in a series of companies’ securities. Instead, the whole of the exchange-traded fund is pegged to the behavior of an index (if you’re not sure what this means, see the first article of this series). So, typically, transaction fees are much lower than those of everyday mutual funds.
Many mutual funds often come with a load; that is, you have to invest some minimum amount of money to buy into the fund. ETFs are almost always load-free.
In our next and final installment of this exchange-traded fund series, we’ll examine the big moment for every investor: the cash out. At this point, you’re ready for the ins-and-outs of redeeming your ETF shares and for a look at how certain tax advantages are built into the process. Until then, keep reading.