What’s The Difference Between Mutual Funds And ETFs?

Mutual funds and exchange-traded funds (ETFs) have a lot in common, but also have some fundamental differences.

Navigating the financial world with its numerous investment options and opportunities can be rather overwhelming. Here we examine two popular (and often confused) investment vehicles – mutual funds and exchange-traded funds (ETFs) – and highlight the similarities and differences between them.

For over a hundred years, mutual funds have been a highly popular choice among investors who are seeking to diversify their portfolios by investing in a variety of securities. Mutual funds are investment vehicles that are made up of a pool of money numerous investors that is used to purchase securities.
Mutual funds are either actively managed by professional fund managers, or passively track an index or industry. Passively managed funds that mirror the components of a market index are known as index funds.
There are thousands of mutual funds that invest solely in a wide variety of assets such as stocks, bonds, cash, and currencies – based on the individual fund’s investment objectives. For example, there are global mutual funds that invest in top performing companies from all over the world, and sector mutual funds that invest in a specific sector of the economy, such as technology or a particular precious metal. There are also those highly diversified mutual funds that invest in a wide assortment of assets from different sectors and categories.

Though similar in structure to mutual funds, ETFs are composed of a basket of securities that are listed and traded on the stock exchange. Some examples of ETFs are the SPDR S&P 500 ETF, which tracks the performance of the S&P 500 index, and the Straits Times Index ETF that tracks the performance of the Singapore Straits Time Index.

Key Similarities 

Diversification
Both mutual funds and ETFs are bundled portfolios of securities that offer investors diversification, mitigating their risks and losses while exposing them to an entire market or specific market segment.

Passive approach
Although investors will find it less costly to achieve diversification through ownership of mutual funds and ETFs than by buying individual stocks and bonds, they do not have any direct influence over which securities to be included in the funds’ portfolios. Both funds are professionally managed by fund managers, who decide which securities to invest in based on individual fund’s investment strategy.

Risk
All investments carry some degree of risk, and mutual funds and ETFs are no exception. They are not immune to market fluctuations, and are not principal-guaranteed.

Key Differences

Method of trading
Mutual funds can only be traded at the end of the day at their net asset value (NAV) price. In short, investors have no control over the timing of their buying and selling of mutual funds. On the other hand, ETFs are priced and traded continuously throughout the trading day and can be bought on margin, sold short, or held for the long-term – just like stocks.
Additionally, as ETFs are traded in the stock market, investors are required to have a stock trading account in order to invest. You do not need such account when it comes to investing in mutual funds.

Flexibility
Investors have the ability to set limit orders and sell short with ETFs. These options are not available with mutual funds.

Fees
ETFs have lower operational and transaction fees than actively invested mutual funds, as they do not require the expertise of professional fund managers to analyse and manage trading activities on an ongoing basis. Besides paying management fees and commissions, mutual funds also have other operating costs like legal fees, accounting and auditing fees.

Minimum investment
Investors can buy as little as a single share of an ETF, while most mutual funds generally require a minimum initial investment – typically between US$500 to US$3,000.

Transparency
Most ETFs offer daily holdings transparency, while mutual funds usually publish their list of holdings quarterly.

Performance
As ETFs mainly track the movement of a particular benchmark index, they will seldom outperform the market, which means investors will most likely not reap massive returns. In contrast, mutual funds have the potential to outperform a comparable index as fund managers can predict and react accordingly to current market movements and trends.

 

Which is right for you?

ETFs are ideal for cost-sensitive investors because of lower fees. Moreover, they can also satisfy investors’ needs for more trading flexibility and holdings transparency, allowing investors to continuously review and monitor their portfolio.
Mutual funds enable both inexperienced and advanced investors to achieve their financial goals in a hassle-free way, without them having to devote much time and energy to investment matters. In other words, investors can leave the intricacies of trading to the fund manager, and spend more time on things that matter to them.

 

The bottom line

Both ETFs and mutual funds offer investors easy access and exposure to a diversified basket of securities. As such, these two groups of funds need not be mutually exclusive, and can serve to complement each other in an investment portfolio. Many investors construct portfolios that incorporate these two types of investment vehicles.

This article was originally published by WEALTH, Asia’s marketplace for investors

 

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