ETFs vs. mutual funds: Understand the difference
Exchange-traded funds (ETFs) and mutual funds are both popular investments with some similar characteristics, but also some important differences.
Before we break them down, let's talk about what these funds are:
- ETFs and mutual funds are both collections, or “baskets,” of individual stocks, bonds, or other investments—in some cases hundreds of them—all pooled together. When you buy a share of the fund, you own a small piece of this big basket of assets.
How they are similar
Both ETFs and mutual funds…
- Are typically less risky than buying individual stocks and bonds. Because ETFs and mutual funds hold so many different individual investments, there's less chance of an overall portfolio loss if one investment goes bad. In other words, both ETFs and mutual funds automatically give you some diversification.
- Have professional managers who pick the investments, so you don't have to. Both types of funds are administered by professional portfolio managers who choose and monitor the stocks, bonds, and other investments that are in the fund.
- Give you a very broad range of investment choices. Among the thousands of ETFs and mutual funds on the market, you can find funds that buy different types of investments (stocks, bonds, and others), or invest in different geographic locations, industries, types and sizes of companies, and much more.
- Are cheaper to buy and sell, compared to trading all the individual stocks and bonds within the fund separately.
How they're different
|How it trades||ETFs are like stocks. You can buy and sell shares directly on major stock exchanges, throughout the day.||
Mutual funds trade once a day, after the market closes. You can place a buy or sell order at any time, but the order executes at the end of the day. The final price you pay for the shares is also determined after the market closes.
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|How much are you required to invest?||You can buy as little as one share of an ETF, meaning it's often less expensive to get into an ETF than into a mutual fund.||Mutual funds usually require a minimum investment dollar amount. You pay the minimum—or more, if you choose—and receive the number of shares that dollar amount purchases, based on that day's share price.|
|Investment style and goals for returns||Many of the best-known ETFs tend to be passively managed index funds, meaning they aim to mirror the performance of a market index like the S&P 500®. Investors typically expect returns similar to the index. Note that not all ETFs fall into this category.||Similar to ETFs, some mutual funds are index funds. But many others are actively managed, meaning professional fund managers draw on their expertise to try to outperform the average returns of a market or index.|
|Expenses you pay||ETFs typically charge their investors lower management fees (known as the expense ratio) than mutual funds. This fee is small, and you don't see it directly—it is subtracted from the fund's assets—but it is important to note because it lowers your real returns.||Mutual funds tend to have higher expense ratios than ETFs. This can be especially true of actively managed funds which charge higher fees for the time and expertise of the fund managers.|
|Other things to know||Like stocks, you can use limit and stop orders to trade ETFs, as well as trade them on margin, use them in certain options trades, and sell short.||It's easier to use mutual funds for automatic investing (where you invest a pre-determined amount at regular intervals, say $100 every month.)|
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