If you are looking to start or rebalance an investment portfolio, you have likely seen a lot of information circulating regarding mutual funds and exchange-traded funds (ETFs). Both of these systems are designed to pool investments into multiple securities, giving investors the most bang for their buck possible—but understanding the differences between these funds is crucial to picking an investment system that works for you.
What is a Mutual Fund?
A mutual fund is a fund that is actively managed by an investor. The investor is able to make purchases at the end of each trading day, where they will try to make decisions that beat the market and have the highest return possible. These funds tax you on the sale of investments inside these vehicles at the same rate as investors that have been in these funds since day one, even if you just joined the party.
What is an ETF?
An ETF is a more passively managed fund and can be purchased and sold like stocks throughout the day. They typically correspond to a specific market index, but because they are more passively managed, they typically carry lower fees and expense ratios.
The Difference Between Mutual Funds and ETFs
While mutual funds and ETFs may be great options for diversifying an investment portfolio, here are the things to note about how they differ from one another:
Their Management Process
Because mutual funds can only be bought and sold at the end of each day, they are considered an investment that is “actively managed”—meaning investors must absorb the higher cost of paying someone to manage the fund. ETFs, however, are typically passively managed and track a pre-selected index, which lends itself to a more hands-off nature and thus fewer fees.
Their Expense Ratios
An expense ratio is the percentage that investors must pay each year to own a fund. Because ETFs are a passively managed structure, they tend to be cheaper for investors—the average ETF expense ratio is just .15%. Actively managed funds tend to be more expensive, costing an average of .67%. Depending on how much you’re investing, a few percentage points can seriously add up.
Their Tax Structure
ETFs tend to be more tax efficient for investors due to how they are traded. When an investor buys an ETF, they do not have to pay capital gains tax unless the shares are sold and profited off of. Mutual funds typically incur higher capital gains taxes because they are bought and sold more frequently by the account manager.
Their Minimum Investment
Because ETFs are structured similar to stocks in their purchasing setup, they can be bought and sold by the share. For mutual funds, there will be a minimum that investors have to allocate to the account (generally $1,000) to even get started on the investment process.
This blog is not considered investment or financial advice from Huskey Financial Group LLC. If you are considering diversifying your investment portfolio and aren’t sure what’s right for you, let us help! We would love to talk you through your options and help you make the most of your money. Contact us today to get started. Investors should consider the investment objectives, risks, charges and expenses of Mutual Funds and ETF's carefully before investing.