An investor's portfolio may include stocks, bonds, and sectors with value or growth options, and investors commonly decide whether a mutual fundor exchange-traded fund (ETF)meets their financial goals.
Mutual funds and ETFs can hold portfolios of investments like stocks, bonds, or commodities. They both adhere to the same regulations, like what they can own or how much can be concentrated in one or a few holdings.
Key Takeaways
- Mutual funds and ETFs may hold stocks, bonds, or commodities.
- Both can track indexes, but ETFs tend to be more cost-effective and liquid since they trade on exchanges like shares of stock.
- Mutual funds can offer active management and greater regulatory oversight at a higher cost and only allow transactions once daily.
Choosing ETFs
Exchange-traded funds trade on exchanges just like common stocks. Most ETFs are index-tracking and aim to match the returns and price movements of an index, such as the , by assembling a portfolio that matches the index constituents.
Passive management generally makes ETFs cheaper than mutual funds with lower expenses than index-tracking mutual funds. Because buyers and sellers are doing business with one another, the managers have far less to do. The ETF providers want the price of the ETF to align as closely as possible to the net asset value of the index. To do this, they adjust the supply by creating new shares or redeeming old shares.
In Jan. 2024, the Securities and Exchange Commission(SEC) approvedthe firstspot marketbitcoinETFs listed on theNYSE Arca,Cboe BZX, andNasdaqexchanges.
Benefits of ETFs
- Buying and selling can occur at any point during a trading session at market pricing.
- ETFs are not priced at the end of the day.
- There’s no minimum holding period. This is especially relevant in the case of ETFs tracking international assets, where the price hasn’t yet been updated, but the U.S. market’s valuation of it has.
- ETFs can reflect the new market reality faster than mutual funds can.
- Investors in ETFs and mutual funds are taxed based on the gains and losses incurred within the portfolios. ETFs engage in less internal trading, and less trading creates fewer taxable events.
Investors only pay capital gains taxes when they sell ETF shares. By holding on to shares, investors delay paying taxes until shares are sold.
Mutual funds are commonly managed by financial institutions such as Vanguard, T. Rowe Price, and BlackRock, either directly or through a brokerage firm. The purchase of a mutual fund is executed at the net asset value of the fund based on its price at the market close.
When investors sell shares, the same process occurs, but in reverse. Some mutual funds assess a penalty of up to 2% of the shares’ value for selling early, typically sooner than 90 days after purchase.
Mutual funds can track indexes, but most are actively managed. Actively managed funds incur high costs for analysts, economic and industry research, company visits, and administration. That typically makes mutual funds more expensive to run—and for investors to own—than ETFs.
Benefits of Mutual Funds
- Mutual funds can be purchased in fractional shares or fixed dollar amounts.
- Minimum initial investments for mutual funds are a base dollar amount and not based on the fund's share price.
- Investors benefit from professional managers when the fund is actively managed.
When Does a Taxable Event Occur for an ETF?
For an all-ETF portfolio, the tax will generally be an issue only if and when investors sell their shares. Just like mutual funds, if an ETF pays dividends, those count as taxable income.
When Are Investors Liable for Gains Earned from a Mutual Fund?
Unless individuals invest through 401(k) or other tax-favored vehicles, mutual funds will distribute taxable gains to investors, even if they merely hold the shares.
What Is Meant by an Open-End or Closed-End Fund?
Mutual funds and ETFs are both open-ended. The number of outstanding shares can be adjusted up or down in response to supply and demand. A closed-end fund (CEF) does not continuously offer its shares for sale but instead sells a fixed number once.
The Bottom Line
ETFs and mutual funds are baskets of individual securities like stocks or bonds. Both offer exposure to a variety of asset classes. Investors can gain more diversification from a mutual fund or ETF than investing in a single stock or bond.
FAQs
Mutual funds are usually actively managed, although passively-managed index funds have become more popular. ETFs are usually passively managed and track a market index or sector sub-index. ETFs can be bought and sold just like stocks, while mutual funds can only be purchased at the end of each trading day.
Is it better to invest in ETF or mutual fund? ›
The choice comes down to what you value most. If you prefer the flexibility of trading intraday and favor lower expense ratios in most instances, go with ETFs. If you worry about the impact of commissions and spreads, go with mutual funds.
Is S&P 500 a mutual fund or ETF? ›
Index investing pioneer Vanguard's S&P 500 Index Fund was the first index mutual fund for individual investors.
What is the downside of ETFs? ›
For instance, some ETFs may come with fees, others might stray from the value of the underlying asset, ETFs are not always optimized for taxes, and of course — like any investment — ETFs also come with risk.
What is more expensive ETF or mutual fund? ›
For the most part, ETFs are less costly than mutual funds. There are exceptions—and investors should always examine the relative costs of ETFs and mutual funds. However—all else being equal—the structural differences between the 2 products do give ETFs a cost advantage over mutual funds.
Why would someone choose an ETF over a mutual fund? ›
ETFs and index mutual funds tend to be generally more tax efficient than actively managed funds. And, in general, ETFs tend to be more tax efficient than index mutual funds. You want niche exposure. Specific ETFs focused on particular industries or commodities can give you exposure to market niches.
Which is safer ETF or mutual fund? ›
Both are less risky than investing in individual stocks & bonds. ETFs and mutual funds both come with built-in diversification. One fund could include tens, hundreds, or even thousands of individual stocks or bonds in a single fund. So if 1 stock or bond is doing poorly, there's a chance that another is doing well.
Do ETFs outperform mutual funds? ›
In many ways mutual funds and ETFs do the same thing, so the better long-term choice depends a lot on what the fund is actually invested in (the types of stocks and bonds, for example). For instance, mutual funds and ETFs based on the S&P 500 index are largely going to perform the same for you.
Do you pay taxes on ETF if you don't sell? ›
At least once a year, funds must pass on any net gains they've realized. As a fund shareholder, you could be on the hook for taxes on gains even if you haven't sold any of your shares.
Do ETFs pay dividends? ›
One of the ways that investors make money from exchange traded funds (ETFs) is through dividends that are paid to the ETF issuer and then paid on to their investors in proportion to the number of shares each holds.
Leveraged ETF prices tend to decay over time, and triple leverage will tend to decay at a faster rate than 2x leverage. As a result, they can tend toward zero.
Can you lose with ETFs? ›
For most standard, unleveraged ETFs that track an index, the maximum you can theoretically lose is the amount you invested, driving your investment value to zero. However, it's rare for broad-market ETFs to go to zero unless the entire market or sector it tracks collapses entirely.
Why I don't invest in ETFs? ›
Low Liquidity
If an ETF is thinly traded, there can be problems getting out of the investment, depending on the size of your position relative to the average trading volume. The biggest sign of an illiquid investment is large spreads between the bid and the ask.
Which is the best ETF to invest now? ›
List of 15 Best ETFs in India
- Nippon India ETF Nifty 50 BeES. ₹ 241.63.
- Nippon India ETF PSU Bank BeES. ₹ 76.03.
- BHARAT 22 ETF. ₹ 96.10.
- Mirae Asset NYSE FANG+ ETF. ₹ 84.5.
- UTI S&P BSE Sensex ETF. ₹ 781.
- Nippon India ETF Gold BeES. ₹ 55.5.
- Nippon India Etf Nifty Bank Bees. ₹ 471.9.
- HDFC Nifty50 Value 20 ETF. ₹ 123.2.
You'll typically pay a commission each time you buy or sell an ETF—but not always. Keep in mind, the smaller your investment and the more frequently you trade, the more impact these commissions will have on your bottom line.
How many mutual funds should I have? ›
While there is no precise answer for the number of funds one should hold in a portfolio, 8 funds (+/-2) across asset classes may be considered optimal depending on the financial objectives and goals of the investor. Further, higher allocation of portfolio to the right fund is of crucial importance.
Should I switch from mutual fund to ETF? ›
If you're paying fees for a fund with a high expense ratio or paying too much in taxes each year because of undesired capital gains distributions, switching to ETFs is likely the right choice. If your current investment is in an indexed mutual fund, you can usually find an ETF that accomplishes the same thing.
Are ETFs better for taxes than mutual funds? ›
ETFs are generally considered more tax-efficient than mutual funds, owing to the fact that they typically have fewer capital gains distributions. However, they still have tax implications you must consider, both when creating your portfolio as well as when timing the sale of an ETF you hold. Internal Revenue Service.
What are two advantages of an ETF over a mutual fund? ›
ETFs have several advantages for investors considering this vehicle. The 4 most prominent advantages are trading flexibility, portfolio diversification and risk management, lower costs versus like mutual funds, and potential tax benefits.
