Confused on what's the difference between an exchange traded fund (ETF) and a mutual fund? You're not alone! In short, mutual funds have been around for decades and ETF's are relatively new. Both are baskets of stocks with a common investing objective.
What Is An Exchange Traded Fund?
An ETF is a security that includes a basket of stocks compiled into one fund. Each fund acts as it's own business entity, and trades like an individual share of stock. Thus, if you purchase one share of an ETF, you get ownership of all the stocks included in that fund.
There are many different kinds of mutual funds. Some that match major stock market indices like the S&P 500, and others are funds created to invest in a total market sector, such as technology.
Exchange traded funds have an annual expense ratio that pays the investment company who manages the funds securities. The expense ratios are usually very cheap, and are a percentage of the amount you have invested in the fund. Most funds charge anywhere between 0.01% to 0.9% plus or minus a couple fractions of a point, annually.
What Is A Mutual Fund?
A mutual fund is much like an ETF in that it is a basket of investments compiled into one fund. Each time you contribute to a mutual fund, you are investing your contributions among the stated investments within that mutual fund.
Shares of a mutual fund are bought and sold only at the end of each trading day, unlike stocks and ETFs. So, when you purchase shares of a Mutual Fund, your transaction will be pending until the end of that trading day and will be purchased at the price of the shares at the end of that day.
Mutual funds have investment objectives stated in the fund prospectus, that lays out the goal of the fund investments. Examples can be growth funds, aggressive growth funds, retirement date funds, or even copy a major index fund like the S&P 500.
Mutual funds charge fees in multiple different ways, depending on the type of fund you purchase:
- Expense ratio: the annual fee charged as a percentage of your amount invested. All mutual funds have expense ratios.
- Front end load fees: A sales commission fee charged up front when purchasing a mutual fund. Not all mutual funds charge front end load fees.
- Back end load fees: A sales commission for selling your mutual fund shares. Not all mutual funds charge back end load fees.
- 12(b)1 service fees: A service fee charged by the investment bank for marketing and selling the fund to investors. Not all mutual funds charge 12(b)1 fees.
The types of fees charged by a mutual fund is based on the type of mutual fund shares you purchase: A shares, B shares or C shares. A shares charge front end load fees, B shares charge back end load fees, C shares charge 12(b)1 fees, and all mutual funds charge annual expense ratios.
Exchange Traded Funds VS. Mutual Funds
So, what's the difference between an ETF and a Mutual Fund? The table below outlines the main differences. Keep in mind that Mutual Funds have been around for decades and are widely known among investors. ETFs are a newer investment vehicle introduced in this modern era of investing, and are slightly more convenient in many ways (depending on who you talk to).
|Trading||They trade intra-day like a share of stock||Transactions are completed at the end of the trading day, and NOT bought/sold intra-day like stocks.|
|Annual Expense Ratio||Very low annual expense ratios (0.01% to 0.9% give or take)||Higher expense ratios (0.5% to 2.5% give or take)|
|Other fees||NONE||Front-end/back-end load fees, 12(b)1 fees|
|Management||Managed by a fund manager or follows a known index||Managed by a fund manager or follows a known index|
|How Fund Investments Are Chosen||Fund managers will pick securities based on the stated fund objective, or the fund will match a common market index.||Fund managers will pick securities based on the stated fund objective, or the fund will match a common market index.|
|Best Suited For…||Passive investors, investors who want to invest in a total industry, index or movement, investors seeking added diversification.||Passive investors, investors who want to invest in a total industry, index or movement, investors seeking added diversification.|