The latter may not be a particularly pressing dilemma. Nevertheless, being aware of the differences and similarities between them can have a profound impact on the amount of money you make and how easily you make it.
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ETFs vs Mutual Funds: Similarities
The first similarity to note between ETFs and mutual funds is that they both allow you to purchase a collection of securities as one investment security. But there are more similarities
- They have great utility in terms of diversifying your portfolio.
- They also tend to invest in the particular market of stocks and bonds.
- The majority of ETFs are passively-managed in much the same way as index mutual funds. That means that they will exactly replicate the performance of the underlying index. Also, the expense ratios are much lower than they are with actively managed funds.
That said, however, the meat of this articles is based squarely on the differences between ETFs and mutual funds. So what are they?
ETFs vs Mutual Funds: Differences
Pooling your money into a mutual fund is essentially pooling it with whatever company that is managing it. You can do this directly or have it done through a broker.
The buy is carried out at the net asset value of the fund which is calculated using the price as quoted when the market closes up for the day. Of course, if you happen to place your order after closing time, that figure will be taken at the end of the next day’s operations.
Predictably, that same process is reversed when you sell your shares but there is a catch. There may be a penalty attributed to some mutual funds if you decide to sell early. This can sometimes amount to 1% of the total value of shares and the period in which a sale is considered early is usually sooner than 90 days after the purchase.
Now ETFs are quite different in this regard. They trade in much the same way as stocks do – between two private investors instead of one investor and some corporate behemoth.
Purchases and sales can happen at any time that takes your fancy at whatever price the market is currently trending. There is no need to wait until the end of the day and there are no penalties tied to the shares for selling out early.
This enhanced flexibility really comes into its own when you consider that ETFs keep track of international assets, where prices that have already been updated in US markets are yet to be updated elsewhere.
Compared to mutual funds, ETFs do a much quicker job of relating new market information.
Another key distinction with ETFs is that they keep track of indexes like S&P 500 and attempt to mirror their returns and price shifts. They do this by putting together a portfolio to match the elements of the index as accurately as possible. Not to say that mutual funds are not capable of doing the same.
However, they are under active management by people who are always looking to usurp the index which they consider to be their benchmark. Also, they can be considerably more expensive. Active management naturally requires a hoard of analysts, extensive research into the economy and different industries and that makes a mutual fund a lot more costly to invest in than an ETF.
Which should you choose?
ETFs? Mutual Funds? Or both? Neither of these is a particularly bad option. The main concern for investors here is the cost involved relative to the gains.
Then there are the different types of investments for which one of the funds will be more beneficial than the other.
It is also useful to tap into the performance history of a fund which will help you evaluate your profit potential with it.
Finally, it is not absolutely necessary for you to choose between them. ETFs and mutual funds can actually work to further diversify your portfolio so long as they do not compromise investment goals or pose too much of a risk.
As you can see, ETFs and mutual funds can be incredibly resourceful and rewarding to invest in, and knowing what sets them apart from each other will help you deal with them a lot better than you otherwise would.