Mutual funds and ETFs: what is the difference?

Mutual funds and ETFs: an overview

Mutual funds and exchange-traded funds (ETFs) have a lot in common. Both types of funds are composed of a variety of different assets and represent a common way for investors to diversify their investments. However, there are key differences in management methods. ETFs can be traded like stocks, while mutual funds can only be purchased at the calculated price at the end of each trading day. Mutual funds are also actively managed, which means that the fund manager decides how to allocate the assets in the fund. On the other hand, ETFs are usually passively managed and are more simply based on specific market indexes.

According to data from the Institute of Investment Companies, as of December 2018, there were 8,059 mutual funds with total assets of US$17.71 trillion. In contrast, ICI’s research report on ETFs stated that the fund has 1,988 ETFs with total assets of US$3.37 trillion. The same period.

Key points

  • Mutual funds usually actively manage the purchase or sale of assets in the fund in an attempt to beat the market and help investors profit.
  • ETFs are mostly passively managed because they usually track specific market indexes; they can be bought and sold like stocks.
  • Compared with ETFs, mutual funds tend to have higher fees and higher expense ratios, which to some extent reflects the higher costs of active management.
  • Mutual funds are either open-ended-trading between investors and the fund, and the number of stocks available is unlimited; or closed-end-the fund will issue a certain number of stocks regardless of investor needs.
  • These three types of ETFs are exchange-traded open-end index mutual funds, unit investment trusts, and trustee trusts.

Mutual Fund

The minimum investment requirements for mutual funds are usually higher than for ETFs. These minimum requirements may vary depending on the type of fund and company. For example, the Vanguard 500 Index Investor Fund requires a minimum investment of US$3,000, while The Growth Fund of America provided by American Funds requires an initial deposit of US$250.of

Many mutual funds are actively managed by fund managers or teams who decide to buy and sell stocks or other securities in the fund to beat the market and help investors profit. These funds are usually more expensive because they require more time, energy, and manpower.

The buying and selling of mutual funds is carried out directly between investors and the fund. The price of the fund will not be determined until the end of the business day when the net asset value (NAV) is determined.

Two mutual funds

There are two legal classifications of mutual funds:

  • Open-end funds. These funds dominate the mutual fund market in terms of volume and assets under management. In open-end funds, the buying and selling of fund shares is carried out directly between investors and fund companies. There is no limit to the number of shares a fund can issue. Therefore, as more and more investors buy into the fund, more stocks will be issued. Federal regulations require a daily valuation process, called mark-to-market, after which the price per share of the fund is adjusted to reflect changes in the value of the investment portfolio (asset). The value of individual shares is not affected by the number of outstanding shares.
  • Closed-end funds. These funds only issue a certain number of shares and will not issue new shares as investor demand grows. The price is not determined by the fund’s net asset value (NAV), but driven by investor demand. The purchase price of stocks is usually higher or lower than the net asset value.

Before deciding whether and how they fit your investment portfolio, it is important to consider the different fee structures and tax implications of these two investment options.

Exchange Traded Fund (ETF)

The cost of entering ETF positions is much lower-as long as the cost of one share, plus fees or commissions. ETFs are created or redeemed in large numbers by institutional investors, and stocks are traded between investors throughout the day, just like stocks. Like stocks, ETFs can be sold short. These terms are important to traders and speculators, but they are of little interest to long-term investors. However, since ETFs are continuously priced by the market, transactions may be conducted at prices that are not true of the net asset value, which may bring arbitrage opportunities.

ETFs provide investors with tax incentives. As a passively managed portfolio, the capital gains realized by ETFs (and index funds) are often lower than actively managed mutual funds.

ETFs are more tax efficient than mutual funds because of how they are created and redeemed.

Examples of mutual funds and ETFs

For example, suppose an investor redeems $50,000 from a traditional S&P 500 index (S&P 500) fund. In order to pay investors, the fund must sell shares worth $50,000. If the sale of appreciated stocks frees up cash for investors, the fund will receive this capital gain and distribute it to shareholders before the end of the year. Therefore, shareholders pay taxes on the turnover within the fund. If ETF shareholders wish to redeem $50,000, the ETF will not sell any stocks in the portfolio. On the contrary, it provides shareholders with “in-kind redemption”, which limits the possibility of paying capital gains.

Three ETFs

There are three legal classifications of ETFs:

  • Exchange-traded open-end index mutual funds. The fund was registered under the Investment Company Act of the United States Securities and Exchange Commission of 1940. Dividends are reinvested on the day they are received and paid to shareholders in cash quarterly.Securities borrowing and lending are allowed, and the fund can use derivatives.
  • Exchange-traded unit investment trusts (UIT). Exchange-traded UITs are also governed by the Investment Company Act of 1940, but they must try to fully replicate their specific indexes, limit single-issue investments to 25% or less, and set additional funds for diversified and non-diversified funds. The weight limit.UIT does not automatically reinvest dividends, but pays cash dividends quarterly. Some examples of this structure include QQQQ and Dow DIAMONDS (DIA).
  • An exchange trade grantor trust. This type of ETF is very similar to a closed-end fund, but the investor owns the relevant shares of the company in which the ETF invests. This includes having voting rights related to becoming a shareholder. However, the composition of the fund has not changed. Dividends will not be reinvested, but paid directly to shareholders. Investors must trade in units of 100 shares. Holding company depository receipts (HOLDR) are an example of this type of ETF.

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