Investing introduces a seemingly endless array of options. Often, funds are touted as a great way to avoid fully committing to any one investment, as they allow you to own a diverse group of assets with just one purchase. But even when you go to look at investment fund options, you’ll find that there are a myriad to choose from.
Two of the most common you will likely come across are ETFs, or exchange-traded funds, and mutual funds. But how do they differ, and how can you know which one is the right fit for your portfolio? Read on for the breakdown.
How do ETFs and mutual funds differ?
Admittedly, ETFs and mutual funds do have a lot in common. “They are both relatively liquid baskets of stocks, bonds and other assets overseen by professional money managers, and can help investors diversify their portfolios,” said CNBC.
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However, they also have some distinctions “that may make one a better financial choice than the other for certain investors,” said the outlet. These include:
Management: One big difference is in how the funds themselves are managed, which in turn impacts both the cost of investing and your potential returns. Generally, mutual funds tend to be actively managed, which means the “fund’s manager picks and chooses securities to buy and sell, and when to do so,” said Bankrate. By contrast, ETFs are more often passively managed, meaning the “fund manager doesn’t select the investments but rather mimics an index that’s already been selected, such as the S&P 500.”
Cost: Passive investing tends to be less costly, and that generally holds true for ETFs vs. mutual funds, with ETFs usually being “significantly cheaper for investors to own than mutual funds,” said CNBC. Additionally, ETFs tend to be more tax-efficient.
Buying and selling: Another major difference is in how you can buy and sell these investments. While ETFs trade on an exchange, just like stocks, allowing for buying and trading at any time the market is open, mutual funds are not priced until the end of the trading day. So although investors technically can place trades at any point in the business day, they “won’t know their transaction’s exact price per share until the end of the day,” said CNBC.
When can ETFs be a good fit for your portfolio?
Ultimately, whether an ETF or a mutual fund makes more sense for your portfolio “all depends on your goals and the type of investor you are,” said Schwab, as well as the specifics of the particular fund. For example, if you are a passive investor focused on tax efficiency and cost savings, a passively managed ETF may be the right move; this can also make sense if you tend to trade actively, as various types of trades “are possible with ETFs, but not with mutual funds,” said Schwab.
When could mutual funds make more sense?
Mutual funds tend to be a better choice for investors who prefer a more active management style, as they are more likely to align with that. Investing in mutual funds can also make sense depending on your specific investment account. For instance, 401(k) plans “often invest in mutual funds and don’t have an ETF option,” and some plans, as well as brokerage accounts, also “allow automatic contributions to mutual funds,” said Bankrate.