Exchange Traded Funds vs Mutual Funds

Based on the different approaches towards investing and the conditions of the financial markets, there are quite a lot differences between mutual funds and Exchange traded funds or ETFs. Here are some put together and contrasted for your reference:

  • The Mutual Funds Are Operated By A Team Of Analysts, quantitative analysis, and other methodologies because they always have the target to achieve some benchmarks. If you take for example the Fidelity Fund (FFIDX), you will find that their investment is quite high in domestic equities. They also strive to deliver a certain amount of return which should be more than that of S&P 500.  On the other hand, Exchange traded funds operate with a “passive” investment strategy and thus incur lower expenses to investors. Take for example SPDR S&P 500 ETF (SPY), which instead of delivering more returns than S&P 500, tries to match their performance. This is a passive investment strategy which helps the ETFs to charge much lower expenses to investors.

  • Another Important Difference Is About The Liquidity Of The Funds. Investors can redeem the mutual funds at net asset value after the trading day while ETFS are traded like stocks. They can be bought and sold to an appropriate counterparty whenever the money market is open. Investors don’t have to be concerned too much about the mutual funds because they can be always redeemed of their net asset value. It is not the same as with ETFs. The arbitrage mechanisms do not allow ETFs from trading at a price other than the specified market value. There are however gaps between NAV and market price that occur in cases of thinly-traded ETFs.

  • The Difference Between Redemption Process And Taxes is another specific point that differentiates the two. In case of mutual funds, the shares can be redeemed against cash by fund managers when the investors sell the assets. On the other hand, ETF shares can be redeemed for cash by Authorized Participants only.  When investors want to purchase an ETF, they don’t buy the ETF from some fund manager, but from another participant. ETF investors thus make use of limit orders when trading. A particular ETF can have a shallow market and thus, it can lead to big run-ups in price.

In both the cases, seemingly the surface result is same, but the tax impact is markedly different. Mutual Fund involves selling the assets which results in making the cash payment to the holder of the share. It can make an impact of capital gains on the stocks which have appreciated by now. The remaining shareholders are now in a taxable circumstance as the trading now depends on the buying and selling of the other investors. ETFs are however more tax efficient if looked from this point of view because if a shareholder wishes to sell his ETFs, he can deliver the shares to another investor.

The underlying holdings need not be sold in the process.The minimum amount needed to be invested is another important point. Mutual Funds need a minimum amount to be invested which can go sometimes as high as $50,000. ETFs on the other hand do not require any minimum investment.

  • The Investment Pattern In Mutual Patterns Is Pretty Simple. For ETFs, there are varied possibilities of investments and strategies that are employed to bet on.

  • The Last, But Not The Least Is About The Dividends. The mutual funds have an advantage of the automatic dividend reinvestment option. They can opt for purchasing additional shares with the cash that they receive. The ETFs behave more like stocks and the dividends get winded up in the brokerage account of the investor. They do need to make another purchase so that the amount can be put back to work.