ETFs Vs. Index Mutual Funds



With the rise of bonds ETFs investors now have more ways than ever before to improve, as well as damage, their fixed income portfolios. Since most mutual funds are allowed to trade securities, the fund may incur a capital gain or loss and generate dividend or interest income for its shareholders.

Generally, ETFs have lower fees and higher daily liquidity compared to mutual fund shares. Mutual funds and exchange-traded funds are sold only by prospectus. With an actively managed mutual fund, a fund manager makes choices about how to allocate fund assets as opposed to assets being purchased simply to track an index.

Mutual funds are very popular among investors, with U.S. assets totaling nearly $19 trillion as of mid-2018, according to the ICI—in large part because most workplace retirement plans, such as 401(k)s, offer mutual funds and not ETFs. The reason is simple: When you buy shares of a mutual fund directly from the mutual fund company, that company must handle a great deal of paperwork to record who you are, where you live and to send you documents.

Capital gains taxes only apply once the investor sells the ETF. Mutual funds accumulate a pool of money that is then invested to pursue the objectives stated in the fund's prospectus. In fact, you can easily create a fully diversified portfolio with only three mutual funds or ETFs, using solely one or the other.

For narrow ETF categories, or even country-specific products that have relatively small amounts of assets and are thinly traded, ETF liquidity could dry up in severe market conditions, so you may wish to steer clear of ETFs that track thinly traded markets or have very few underlying securities or small market caps in the respective index.

But only through mutual funds can you benefit from a professional fund manager's efforts in actively balancing and rebalancing your portfolio in response to big-picture economic fundamentals. Unlike mutual funds, shares of ETFs are not individually redeemable directly with the ETF.

Mutual funds generally break down into two categories: actively managed and passive. With an ETF, you buy and sell based on market price—and you can only trade full shares. Spreads: In addition to commissions, investors also pay the "spread" when buying or selling ETFs.

But if you're making frequent investments into a college fund or IRA account, a no-load mutual fund can be the way to go. It could help you avoid the trading commission you may be individual retirement account charged when buying and selling ETF shares. Most ETFs are like open-end funds, with no limit on shares; however, there are two "trust" types, one of which limits investment options while the other gives shareholders direct ownership in the underlying stocks.

You do this by contacting the mutual fund company directly and telling them you want to acquire or redeem shares. For example, imagine you buy 1 ETF that holds all 25 stocks and costs $50 a share, and you enjoy Vanguard's commission-free trading. Since shares in a mutual fund actively trade and the fund itself is actively managed , they sometimes rack up large management fees.

As we mentioned above, ETFs and index mutual funds usually have lower fees than actively managed mutual funds. ETFs are not mutual funds. For investors trying to decide whether mutual funds or ETFs are the right choice, it helps to delve a bit deeper in how they compare and contrast.

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