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Mutual funds and exchange-traded funds (ETFs) are more similar than not.
They are both baskets of many individual stocks, bonds and other securities that help you diversify your investments in the stock market. Instead of selecting individual assets yourself, you can use any type of fund to instantly get hundreds, thousands, or tens of thousands of different stocks and bonds.
“Imagine going to a restaurant and wanting to try a little bit of everything on the menu. Instead of buying an individual dish, you decide to buy the tasting plate,” said Rita-Soledad Fernández Paulino, financial educator at Wealth Para Todos. “Mutual funds and ETFs are the sampler plates.”
Read on to learn more about mutual funds and ETFs and how to decide which one is right for you.
Mutual Funds vs ETFs: Similarities & Differences
Investors love both mutual funds and ETFs because of the way they distribute money in the stock market. This lowers your risks and prevents you from investing in just one stock, which could hurt you if that company goes through a recession.
Only a few key differences distinguish mutual funds and ETFs.
How they are managed
Both ETFs and mutual funds can be index funds, meaning they track the performance of a particular market or index. There are many index funds, but they are often recommended that mirror the S&P 500 (the 500 largest publicly traded companies in the US).
Both mutual funds and ETFs are low-risk investments, even for newbies. Beginners may want to look into ETFs before graduating into mutual funds, even though both perform about the same.
The best ETFs are passively managed, meaning they track a specific index rather than having a fund manager pick the stocks. These ETFs have lower expense ratios or fees, and usually have no commissions, making for expert favorites. There is usually no minimum required to start investing with ETFs, and ETFs also offer investors tax benefits.
On the other hand, some mutual funds can be actively managed, usually by an account manager. So the difference here is that it can cost more to buy.
How they are traded
Like stocks, ETFs are bought and sold on a stock exchange. So, ETFs constantly see price fluctuations throughout the day. Mutual fund orders only go through once a day, with buyers and sellers getting the same price.
“ETFs are bought and traded like stocks, meaning you can buy for the price of one share,” Paulino says. “Investment funds are bought for a fixed price. This can make buying ETFs more affordable.”
What do they cost?
ETFs generally have lower costs than mutual funds and lower minimum purchases. “Yields can fluctuate, but costs are more consistent with ETFs,” said Cait Howerton, Certified Financial Planner and Lead Planner at Facet Wealth.
You can buy an ETF for just the price of one share, and that cost varies depending on the ETF. For example, it could be a few dollars or a few hundred dollars.
Many mutual funds have minimum initial investments that are not based on the fund’s share price. Remember that mutual fund orders are executed once a day, so they have a fixed dollar amount.
When to Buy Mutual Funds and ETFS
You can buy mutual funds and ETFs through a bank, mutual fund, fund manager, brokerage account, or any other company that buys and sells them. If you have actively managed accounts, you can contact your account manager about purchasing specific accounts.
Do ETFS and Mutual Funds Pay Dividends?
Both mutual funds and ETFs have the capacity to pay dividends, but this depends on each fund.
If a mutual fund or ETF has a stock or other security that pays its shareholders through dividends, then that mutual fund or ETF will return dividends to you, the investor. You can also make capital gains through a mutual fund or ETF.
Which is safer?
Both mutual funds and ETFs are considered low-risk investments compared to cherry-picked stocks and bonds. While investing in general always involves a certain amount of risk, both mutual funds and ETFs are roughly the same level. It depends on the individual mutual fund and ETF you invest in.
“Neither an ETF nor a mutual fund is safer simply because of its investment structure,” Howerton says. “Instead, ‘safety’ is determined by what the ETF or mutual fund owns. A fund with greater exposure to equities will typically be riskier than a fund with greater exposure to bonds.”
Since some mutual funds can be actively managed, there’s a chance those funds will perform both better and worse in the stock market, Paulino says.
Mutual Funds or ETFs: Which Should You Choose?
The fund you choose will depend on many factors, such as the type of investor you are, the fund, the type of account you have and your overall strategy. Howerton says ETFs are a great place to start.
“ETFs are hard to beat because of their much lower costs, ease of purchase, and tax efficiency,” she says. The overhead on ETFs is much lower compared to mutual funds, which can be a deciding factor. Keep in mind the costs and fees when choosing between mutual funds and ETFs. Every little charge adds up.
“A novice investor should start with passively managed mutual funds or ETFs with low expense ratios,” says Paulino. “Anything below 0.5% is great, and keep in mind that some expense ratios can be as low as 0.02%. To reduce tax liability, they should start investing in tax-advantaged accounts like a Roth IRA.