Mutual funds have roots going back to the 18th century and are a favored investment for many people. Exchange-traded funds (ETFs) are newer and have been around for fewer than 20 years. Both funds offer advantages and disadvantages to the investor. Everyone should weigh the differences and decide on the best choice for his or her circumstances.
A major difference between the two is that ETFs can be traded at any time during market hours. If an ETF reaches a high or low at a particular time and an investor wants to buy or sell right at that moment, he or she can do so. Mutual funds are traded only at the end of the day after market hours. Mutual fund companies determine the net asset value of the fund’s securities and divide the total number of shares outstanding to figure the amount paid to investors cashing out or the amount to charge those buying in.
The costs to own these two funds are different as well. ETFs have fees about half of what mutual funds do. The shares in a mutual fund are actively traded and managed. There are managers who watch out for underperforming securities and invest in only the top-performing assets. This can bring about larger management fees. An ETF is just one transaction, which leads to lower commissions and fees.
Mutual fund holders usually will have to pay more in taxes than ETF holders. When a mutual fund holder cashes out, the shares can be sold to pay for it. This will lead to a capital gains distribution, which is taxable to everyone who owns a piece of that particular fund. You are essentially paying this tax even when you have done nothing but buy and hold onto it. ETFs are usually exempt from this as transactions are between two parties.
ETFs and mutual funds have different disclosure requirements. ETFs disclose daily what securities their portfolio consists of and what proportions are in each. Mutual funds only disclose this information on a quarterly basis. Those investors who like to buy and hold will not mind this gap between disclosures, but someone who has a more active approach and wants to keep constant tabs on what is going on with his or her investments will like the ETF’s disclosure practices better.
Mutual funds have been around for quite some time, whereas ETFs are rather new and some might say improved. According to the Investment Company Institute (ICI), as of June 2012 ETFs combined assets tallied in at over $1 trillion but mutual funds are way ahead at just over $12 trillion. Percentage-wise that would be about 92% to mutual funds and 8% to ETFs. These figures do not mean that ETFs are not as good of an investment; it means that they have not had as much time to build up. Most 401K plans, which many people invest in through their employer, have only mutual funds. Both have a place in the investing world dependent on what kind of investor a person is.