Exchange-traded fund (ETFs) and mutual funds have a lot in common, but with some important differences. Discover what may be right for you.
ETFs provide diversification with nimble flexibility
Like mutual funds, ETFs are comprised of a basket of equities, fixed income or commodities, depending on the fund’s primary focus. For example, an index ETF will mirror the performance of a particular index, such as the S&P 500® or the NASDAQ 100. Most ETFs, such as index products, are passively managed, meaning they don’t rely on fund managers to research, forecast, and make trading decisions—this often results in a lower expense ratio.
What is most distinctive about ETFs is that they can be traded intraday on market exchanges, much like an individual stock. This provides several advantages:
- ETFs can be purchased on margin and even sold short.
- Sophisticated traders can use ETFs as part of an options trade, a hedge, or any strategy that relies on short positions.
- Day traders can take advantage of intraday price movements and high liquidity, like they would for many stocks.
- Traders can place limit and stop limit orders with an ETF.
Mutual funds offer diversification for the long-term investor
Mutual funds have been around for nearly 100 years, and many long-term investors are familiar with the advantages of diversification. Mutual funds have been instrumental in attracting the general public to stock market investing due to their simple, “hands-off” appeal. Many investors take on a buy-and-hold strategy when they invest in mutual fund shares, since they are not traded daily like an ETF. This feature makes them the foundation of many long-term oriented portfolios. Some advantages of mutual funds:
- They are available in a myriad of markets, sectors, and asset classes, giving the individual investor a very wide variety of choices.
- Most mutual funds are professionally managed where professional money managers do the research, pick the investments and monitor the performance of the fund.
- Choose from more than 9,000 mutual funds—many with no loads and no transaction fees3.
How do you decide which one is right for you?
Both ETFs and mutual funds have their pros and cons. One or the other might be better suited to your trading strategy, and it’s quite possible both have a place in your portfolio. Some factors that you should consider include:
- Whether a particular fund best fits your investing profile or financial goals
- Desire to trade intraday, create short position, or use as part of an options or trading strategy
- Initial trading commissions or transaction costs
- The fund’s management costs passed on to investors (expense ratio percentage)
- Whether you can meet any mutual fund investment minimums