Exchange-Traded Funds (ETF) and Mutual Funds: What are they?

Post Written by: Derek J. Hinebaugh

If you have an investment portfolio or are considering improving your retirement strategy, we’re sure you’ve heard the word: diversify.

Diversification is an important aspect of any investment management program or retirement plan. Choosing where to allocate funds to individual stocks and bonds can take a lot of time and research, but what if there was a way to gain access to a portfolio of diversified stocks and bonds with minimal cost and effort?

Selecting exchange-traded funds (ETF) and mutual funds can help achieve this goal.

What are these? How are they similar? How are they different? What about taxes? We’re exploring these questions and more, below.

What are these types of funds and how are they similar?

Exchange-traded funds (commonly referred to as ETFs) and mutual funds pool money from numerous investors and invest in an assortment of securities. The securities in these funds can range anywhere from stocks and bonds to commodities and precious metals such as wheat and gold.

The primary benefit of both these investment vehicles is their diversification benefits. An ETF and a mutual fund can each hold tens, hundreds, and even thousands of individual securities in its portfolio.

If we think of a stock fund, for example, if one or two stocks perform poorly on a given day there is a chance others are performing well. This helps reduce risk and overall losses, via a diversified balance. Think of these funds as a way to not put all your eggs in one basket.

There are thousands of ETFs and mutual funds available to investors, but many offer different strategies. This allows investors to have a wide variety of investment options.

Some of these strategies can be as simple as replicating the S&P 500 Index or a fund that invests in companies benefitting from the spending habits of millennials. The options are endless.

How are ETFs and Mutual Funds Different?

Now that we know the similarities of ETFs and mutual funds, what are the differences?

Possibly the biggest difference between the two is how they are purchased and sold.

Exchange-traded funds, as the name implies, are bought and sold at a marketplace, just like an individual stock. The price of the ETF fluctuates throughout the trading day and investors can buy shares at the market price at any time. Just like stocks, an ETF can be traded multiple times during trading hours. Buying and selling the same day is also permitted.

Mutual funds, on the other hand, trade once per day after the market closes. This means you will receive the same price as everyone else who either bought or sold the fund that day. Rather than transacting with numerous buyers and sellers through an exchange, mutual fund transactions occur directly with the fund manager. Also, the purchase amount can be based on a dollar amount or a share amount (ETF’s must be purchased in shares).

Another difference between ETF’s and mutual funds is the investment minimums.

ETF’s do not have an investment minimum. The cost of gaining access to an ETF is the price of one share. The price of an ETF can range from just a few dollars to a few hundred dollars, depending on the fund.

Compared to an ETF, most mutual funds, do require a minimum investment amount. Some may require a minimum investment of $500 or more, depending on the fund and the share class.

Are there any tax implication differences?

ETFs and mutual funds will both have a tax impact if one were to sell them in their taxable account at a gain, but both can also generate income or capital gains distributions.

ETFs have fewer taxable events within the portfolio compared to actively managed mutual funds. Some ETFs will also payout income in the form of a dividend.

Mutual funds will have more taxable events as managers buy and sell securities to satisfy client redemptions. As the gains are realized, they are passed through to the investors in the fund. Many mutual funds will pay out their capital gains near the end of the year, but there are some that will distribute gains earlier or even two to three times a year.

etf chartWhether it be saving for retirement, funding your child’s college fund, or saving up to buy your dream car, both ETFs and mutual funds provide efficient diversification in your portfolio to help achieve your goals. If you or a loved one is looking to grow assets in an efficient fashion or are nearing retirement and want to make sure you have sufficient funds, maybe it’s time to sit down with a trusted financial advisor and discuss how ETFs and mutual funds can help achieve your dreams. Our advisors and investment professionals are always ready to have a conversation about how we can help with your financial situation. Connect with us anytime at 717-393-9721 or info@domaniwealth.com.

 

 

Important Disclosure

Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this article serves as the receipt of, or as a substitute for, personalized investment advice from Domani. A copy of Domani’s current written disclosure brochure discussing our advisory services and fees continues to remain available upon request.

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