An investor's portfolio may include stocks, bonds, and sectors with value or growth options, and investors commonly decide whether a mutual fundor exchange-traded fund (ETF)meets their financial goals.
Mutual funds and ETFs can hold portfolios of investments like stocks, bonds, or commodities. They both adhere to the same regulations, like what they can own or how much can be concentrated in one or a few holdings.
Key Takeaways
- Mutual funds and ETFs may hold stocks, bonds, or commodities.
- Both can track indexes, but ETFs tend to be more cost-effective and liquid since they trade on exchanges like shares of stock.
- Mutual funds can offer active management and greater regulatory oversight at a higher cost and only allow transactions once daily.
Choosing ETFs
Exchange-traded funds trade on exchanges just like common stocks. Most ETFs are index-tracking and aim to match the returns and price movements of an index, such as the , by assembling a portfolio that matches the index constituents.
Passive management generally makes ETFs cheaper than mutual funds with lower expenses than index-tracking mutual funds. Because buyers and sellers are doing business with one another, the managers have far less to do. The ETF providers want the price of the ETF to align as closely as possible to the net asset value of the index. To do this, they adjust the supply by creating new shares or redeeming old shares.
In Jan. 2024, the Securities and Exchange Commission(SEC) approvedthe firstspot marketbitcoinETFs listed on theNYSE Arca,Cboe BZX, andNasdaqexchanges.
Benefits of ETFs
- Buying and selling can occur at any point during a trading session at market pricing.
- ETFs are not priced at the end of the day.
- There’s no minimum holding period. This is especially relevant in the case of ETFs tracking international assets, where the price hasn’t yet been updated, but the U.S. market’s valuation of it has.
- ETFs can reflect the new market reality faster than mutual funds can.
- Investors in ETFs and mutual funds are taxed based on the gains and losses incurred within the portfolios. ETFs engage in less internal trading, and less trading creates fewer taxable events.
Investors only pay capital gains taxes when they sell ETF shares. By holding on to shares, investors delay paying taxes until shares are sold.
Mutual funds are commonly managed by financial institutions such as Vanguard, T. Rowe Price, and BlackRock, either directly or through a brokerage firm. The purchase of a mutual fund is executed at the net asset value of the fund based on its price at the market close.
When investors sell shares, the same process occurs, but in reverse. Some mutual funds assess a penalty of up to 2% of the shares’ value for selling early, typically sooner than 90 days after purchase.
Mutual funds can track indexes, but most are actively managed. Actively managed funds incur high costs for analysts, economic and industry research, company visits, and administration. That typically makes mutual funds more expensive to run—and for investors to own—than ETFs.
Benefits of Mutual Funds
- Mutual funds can be purchased in fractional shares or fixed dollar amounts.
- Minimum initial investments for mutual funds are a base dollar amount and not based on the fund's share price.
- Investors benefit from professional managers when the fund is actively managed.
When Does a Taxable Event Occur for an ETF?
For an all-ETF portfolio, the tax will generally be an issue only if and when investors sell their shares. Just like mutual funds, if an ETF pays dividends, those count as taxable income.
When Are Investors Liable for Gains Earned from a Mutual Fund?
Unless individuals invest through 401(k) or other tax-favored vehicles, mutual funds will distribute taxable gains to investors, even if they merely hold the shares.
What Is Meant by an Open-End or Closed-End Fund?
Mutual funds and ETFs are both open-ended. The number of outstanding shares can be adjusted up or down in response to supply and demand. A closed-end fund (CEF) does not continuously offer its shares for sale but instead sells a fixed number once.
The Bottom Line
ETFs and mutual funds are baskets of individual securities like stocks or bonds. Both offer exposure to a variety of asset classes. Investors can gain more diversification from a mutual fund or ETF than investing in a single stock or bond.
FAQs
Mutual funds and ETFs may hold stocks, bonds, or commodities. Both can track indexes, but ETFs tend to be more cost-effective and liquid since they trade on exchanges like shares of stock. Mutual funds can offer active management and greater regulatory oversight at a higher cost and only allow transactions once daily.
Do ETFs pay more than mutual funds? ›
ETFs expense ratios generally are lower than mutual funds, particularly when compared to actively managed mutual funds that invest a good deal in research to find the best investments.
Is S&P 500 a mutual fund or ETF? ›
An index fund is a type of mutual fund that tracks a particular market index: the S&P 500, Russell 2000, or MSCI EAFE (hence the name). Because there's no original strategy, not much active management is required and so index funds have a lower cost structure than typical mutual funds.
What is the downside of ETFs? ›
For instance, some ETFs may come with fees, others might stray from the value of the underlying asset, ETFs are not always optimized for taxes, and of course — like any investment — ETFs also come with risk.
Is it better to invest in ETFs or mutual funds? ›
ETFs and index mutual funds tend to be generally more tax efficient than actively managed funds. And, in general, ETFs tend to be more tax efficient than index mutual funds. You want niche exposure. Specific ETFs focused on particular industries or commodities can give you exposure to market niches.
Is an ETF riskier than a mutual fund? ›
In terms of safety, neither the mutual fund nor the ETF is safer than the other due to its structure. Safety is determined by what the fund itself owns. Stocks are usually riskier than bonds, and corporate bonds come with somewhat more risk than U.S. government bonds.
Do I pay taxes on ETFs if I don't sell? ›
At least once a year, funds must pass on any net gains they've realized. As a fund shareholder, you could be on the hook for taxes on gains even if you haven't sold any of your shares.
How do you tell if a fund is a mutual fund or ETF? ›
While they can be actively or passively managed by fund managers, most ETFs are passive investments pegged to the performance of a particular index. Mutual funds come in both active and indexed varieties, but most are actively managed. Active mutual funds are managed by fund managers.
Do ETFs pay dividends? ›
One of the ways that investors make money from exchange traded funds (ETFs) is through dividends that are paid to the ETF issuer and then paid on to their investors in proportion to the number of shares each holds.
What is the best ETF to invest in? ›
7 Best ETFs to Buy Now
| ETF | Expense Ratio | Year-to-date Performance |
|---|
| Global X Copper Miners ETF (COPX) | 0.65% | 26.2% |
| YieldMax NVDA Option Income Strategy ETF (NVDY) | 1.01% | 12.9% |
| iShares Semiconductor ETF (SOXX) | 0.35% | 14.9% |
| Simplify Interest Rate Hedge ETF (PFIX) | 0.50% | 22.9% |
3 more rowsMay 7, 2024
Market risk
The single biggest risk in ETFs is market risk. Like a mutual fund or a closed-end fund, ETFs are only an investment vehicle—a wrapper for their underlying investment. So if you buy an S&P 500 ETF and the S&P 500 goes down 50%, nothing about how cheap, tax efficient, or transparent an ETF is will help you.
Why am I losing money on ETFs? ›
Interest rate changes are the primary culprit when bond exchange-traded funds (ETFs) lose value. As interest rates rise, the prices of existing bonds fall, which impacts the value of the ETFs holding these assets.
Are ETFs good for beginners? ›
The low investment threshold for most ETFs makes it easy for a beginner to implement a basic asset allocation strategy that matches their investment time horizon and risk tolerance. For example, young investors might be 100% invested in equity ETFs when they are in their 20s.
Why would you want a mutual fund over an ETF? ›
Unlike ETFs, mutual funds can offer more specific strategies as well as blends of strategies. Mutual funds offer the same type of indexed investing options as ETFs but also an array of actively and passively managed options that can be fine-tuned to cater to an investor's needs.
Which ETF has the highest return? ›
100 Highest 5 Year ETF Returns
| Symbol | Name | 5-Year Return |
|---|
| FNGO | MicroSectors FANG+ Index 2X Leveraged ETNs | 50.00% |
| TECL | Direxion Daily Technology Bull 3X Shares | 42.20% |
| GBTC | Grayscale Bitcoin Trust | 40.63% |
| SOXL | Direxion Daily Semiconductor Bull 3x Shares | 36.15% |
93 more rowsETFs offer advantages over stocks in two situations. First, when the return from stocks in the sector has a narrow dispersion around the mean, an ETF might be the best choice. Second, if you are unable to gain an advantage through knowledge of the company, an ETF is your best choice.
Are ETFs better for taxes than mutual funds? ›
ETFs are generally considered more tax-efficient than mutual funds, owing to the fact that they typically have fewer capital gains distributions. However, they still have tax implications you must consider, both when creating your portfolio as well as when timing the sale of an ETF you hold.
Do ETFs make more money than stocks? ›
Investing in an individual stock can deliver very high returns, and you won't be taxed on any capital gains until you sell, in a taxable account. A single stock can potentially return a lot more than an ETF, where you receive the weighted average performance of the holdings.
What is the biggest advantage of an ETF over other funds? ›
Positive aspects of ETFs
The 4 most prominent advantages are trading flexibility, portfolio diversification and risk management, lower costs versus like mutual funds, and potential tax benefits.
Should I sell my mutual funds and buy ETFs? ›
If you're paying fees for a fund with a high expense ratio or paying too much in taxes each year because of undesired capital gains distributions, switching to ETFs is likely the right choice. If your current investment is in an indexed mutual fund, you can usually find an ETF that accomplishes the same thing.
