How are ETFs Different from Mutual Funds?
When you’re learning about investments, you’ll often find mutual funds and exchange-traded funds (ETFs) mentioned together. These funds have one big thing in common: they offer a basket of securities within a single investment. Both ETFs and mutual funds can also help you to invest in sectors or asset classes that might otherwise be difficult or expensive to get into, like real estate, foreign markets, commodities or bonds.
In spite of their similarities, there are many important differences that you should learn about before you make an investment, such as differing investment objectives, management, and transaction costs. Here is an overview of some of the ways that mutual funds and ETFs are different.
|Trade timing and share price||Orders must be entered before the market closes to receive that day's price, and shares are priced at the end of the trading day.
A mutual fund share price is called its "net asset value" or NAV.
|Orders are filled throughout the trading day at the current market price, and share prices fluctuate throughout the trading day (in other words, they trade more like stocks).|
|Trading costs – online trades||No transaction fee funds: we offer over 500 no-load mutual funds with no transaction fees.
Other no-load mutual funds can be purchased online for $19.95* per trade.
|Online ETF trades are $6.95*.|
|Sales charges ("loads")||Can be offered with or without sales charges. We only offer no-load mutual funds.
Costs and other expenses apply to continued investment in no-load funds and you can find the details in the fund's current prospectus.
|No additional sales charges or "loads"(but commissions still apply).|
|Buying and selling shares||The mutual funds issue new shares for each new investor that buys from the fund. You can do this through a broker, or sometimes directly from the fund company.
Shares can be “redeemed” from the fund once per day.
|Shares trade on exchanges (in the secondary market), and are generally bought and sold through your broker.|
|Management||Can be actively or passively (tied to an index) managed.||ETFs are generally indexed, or passively managed (but there are some actively-managed ETFs out there).|
|Minimum investment amount||Each mutual fund can set its own minimum initial investment amount. The minimum investment requirement is in each fund's prospectus.
If purchasing in an Automatic Investment Plan, some funds require the minimum investment amount be met before automatic investments for smaller amounts can be set up.**
|For online trades, the minimum investment is the amount to purchase one share plus trading costs.
If purchasing in an Automatic Investment Plan, there is no minimum purchase amount.**
|Dividends and capital gains||Paid out on a schedule, generally monthly, quarterly or annually. Investors can take distributions in cash or reinvest them into additional shares.
Sometimes a fund may have to sell securities to redeem shares for another investor. If that’s the case, you may receive a capital gains distribution.
|If an investor wishes to reinvest dividends, the ETF must be eligible for a dividend reinvestment program, but you can reinvest any ETF dividends automatically with your ShareBuilder account.
Due to the passive nature of ETFs, capital gains are usually not realized unless there is a change in the ETF's tracking index.
|Tax implications||Depends on the investment objective of the mutual fund. Some mutual funds seek tax-free interest (municipal bond funds); some are managed to be tax-efficient.
Depending on a fund's portfolio turnover (or other investors’ redemptions – see above), realized long and short-term capital gains are passed along to shareholders.
|Depends on the sector or index the ETF invests in; e.g. municipal bond ETFs may generate tax-free income.
Generally, because ETFs track an index, they do not realize as many gains and losses, and so less is passed on to ETF shareholders.
|Expenses||Varies based on the fund company and investment objective. Large index funds can have very low expense ratios. Smaller, more actively managed funds or those that invest in some sectors can have higher expenses.||Because most ETFs track an index, expenses are generally lower than actively managed securities. There are some actively managed ETFs, and those will have higher expenses.|
|Margin||Mutual funds are not considered to be margin-eligible securities, because each mutual fund share is newly created for each investment in the fund.||ETFs can be bought on margin.|
|Transparency||Investment companies are only required to update their prospectus quarterly, and if it’s an actively managed fund, holdings are subject to change.
Passively managed index mutual funds are more transparent than actively managed funds.
|Generally, because ETFs track an index, they have greater transparency than actively managed mutual funds.|
Keep in mind, all investments carry risk, including the possible loss of the principal amount invested. An investor should consider individual risk tolerance, time horizon and financial situation before making an investment.