If you are looking to invest, you may have heard of both mutual funds and exchange traded funds (ETFs). These two types of investment vehicles may sound similar, but they have significant differences that can greatly affect how much money you make or lose on your investment over time. In this article, we’ll discuss the difference between these two investment vehicles, so you can choose the one that best fits your personal investing needs.
Types of Exchange Traded Funds
There are several types of exchange traded funds (ETFs), including index, sector, currency, commodity and actively managed. All of these investment vehicles offer similar tax benefits to investors; however, they each have a different approach to tracking an underlying index or asset. The type of ETF you choose should be based on your investment goals. For example, if you’re looking for global diversification with low-cost access to various assets classes—including commodities—an ETF may be your best option.
How are ETFs different from Mutual Funds?
Exchange-traded funds (ETFs) are a form of investment that allows you to invest in a large basket of investments like a mutual fund, but they trade like stocks. Unlike mutual funds, ETFs are bought and sold during market hours at continuously fluctuating prices on stock exchanges throughout the day. This means an ETF is subject to price volatility just like individual stocks.
Who uses ETFs?
Both ETFs and mutual funds are investment vehicles for buying a basket of stocks or bonds. An ETF is more like a traditional stock that trades in real time, whereas mutual funds trade at set times throughout each day. When investing in an ETF, you own shares of an underlying index such as the S&P 500—you aren’t purchasing shares of a company directly.
Why use ETFs instead of Mutual Funds?
Exchange-traded funds (ETFs) are a viable alternative to mutual funds. In some cases, they're better suited to investors' needs. While there are plenty of differences between ETFs and mutual funds, one thing you can count on is that they both offer diversification, cost-efficiency, simplicity, transparency and tax efficiency. Investors who want or need any of these features should consider using either ETFs or mutual funds—or both.
Which investment vehicle should you choose?
This all depends on your goals, investment philosophy, and what type of account you are invested in. There are advantages and disadvantages to both. Our recommendation is to do more research on how each investment works and make an informed decision based on the facts. Check out our additional articles written on each of these investments "How Does an ETF Work?" and "How Does a Mutual Fund Work? Everything you need to know"