Mutual Fund vs. ETF: What Should You Choose?
Whether you should choose mutual funds over ETFs or vice-versa has been a topic of debate for quite some time. Mutual funds and ETFs have a lot in common. They use similar ways of investment- they pool in funds and invest the same in different types of stocks. The investor takes ownership in selected investments and diversifies his portfolio into a broad mix through a single fund purchase. However, the differences between the two types of investments lie within the risks and benefits that they offer.
Here we will discuss the five parameters on which mutual funds and ETFs differ which will help you choose the right one for yourself.
1. Way of Trading
Though mutual funds and ETFs both are based on an index, mutual funds are priced and traded at the end of each trading day whereas ETFs are traded throughout the day just like stocks. The price of ETFs is directly based on stock market value with supply and demand playing major roles. Price of mutual fund is based on the NAV which is the value of fund assets minus liabilities divided by the number of shares. An important thing to note here is that ETFs give you the power of buying and selling throughout the day with their stock-like trading structure but they are not normally intended for such trading. So brokerages may require you to hold on to the ETFs for a certain period otherwise a fee will be charged. Plus, more trading means more commission.
ETFs are more tax-efficient as compared to mutual funds due to their trading structure. They only incur taxes when you sell the funds as opposed to mutual funds wherein you will have to pay capital gains taxes when the shares within the fund are traded during the life of your investment. So, the investor has control over the tax consequences and he can choose when to buy or sell so that the tax bills are low.
Because of their simplistic nature of trading, ETFs are typically more cost-effective than mutual funds. The cost of managing the fund, running the fund, administration when added to the brokerage commission can increase the total bill. The expense ratio in case of an average ETFs can be as low as 0.44% whereas mutual fund expense ratio is usually between 0.5% and 1% but can go higher up to 2.5% in case of actively managed funds.
Mutual funds are managed by professionals who use their investment expertise to make the most of the current market condition. Such active management adds up to the cost of mutual funds as the managers would like a fair sum for their time and expertise. On the other hand, ETFs are passively managed as they automatically track a pre-selected index. At the same time, some actively managed ETFs and passively managed mutual funds also exist in the market.
It is difficult for an investor to move his managed portfolio to a different investment firm. The current firm may require them to close out fund positions before the transfer. Such untimely trades can result in losses for the investor along with the risk and commission associated with liquidating the funds in the portfolio. ETFs, on the other hand, provide a smooth switch benefit as the transfer process is clean and simple.
The Bottom Line
As you can see, there are certain aspects on which ETFs come out stronger as they offer more trading flexibility, more transparency, tax benefits, and cost-efficiency. But at the same time, there are mutual funds managed by investment experts, who certainly have better knowledge in trading and they also do not require the commission to be paid for each trading.
A number of factors are involved in making mutual funds and ETFs what they are. There can be no set answer as to which one of the two should be chosen. You will have to consider your overall investment strategy, tax-saving strategy and how you would like to invest your money. Before selecting any one of these, you must do good research to find out under the hood fees and charges. For best investment advice, apply here, our investment advisory team will contact you shortly.