Investors are encouraged to make mutual funds part of their financial portfolio. Still, many investors do not understand the difference between mutual funds, stocks, and exchange-traded funds (ETFs), which adds to investor confusion, particularly new investors. Some novice investors even think mutual funds are exchange-traded.
Mutual funds are not exchange-traded on any of the five different stock markets. Instead, fund managers deal directly with the fund once per day after markets close at 4:00 p.m. ET.
In the rest of this article, I will talk about the main difference between mutual funds and ETFs, and explain why you would want to choose one versus the other. So, read on!
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Table of Contents
Why Aren’t Mutual Funds Exchanged Traded?
Mutual funds are purchased once after the stock markets close each day. Because mutual funds hold securities in hundreds of companies, it would be impossible to know the fund’s worth until stock prices have settled for the day.
To review, when you invest in stocks, you are dealing with one company.
Mutual funds bundle several companies into one investment. This bundling means there could be hundreds of stocks and other securities in one mutual fund.
Mutual Funds operate on a Net Asset Value (NAV), which is the fund’s total assets minus its liabilities, and the value is calculated at the end of each day and used as the per-share value.
This piece of the equation is crucial to understanding why mutual funds cannot be exchange-traded. When you purchase a mutual fund, you are purchasing a part of a company. With ETFs, you buy a share of an asset “basket” that has a unique ticker that you can track throughout the day.
In other words, the ETF fund provider creates a “basket” to track the provider’s assets and then sells shares of that “basket” to other investors. You can look at the basket as a trust of bundled stocks.
Therefore investors do not own the assets but rather a part of the trust created from borrowed stock.
This difference is significant because you receive cash when you sell a mutual fund back to the company. When you sell an ETF, it is considered an “in-kind trade”. This in-kind trade is why there are few tax implications for investors who invest in ETFs.
Exchange-Traded Funds (ETFs)
Investopedia has one of the best definitions for Exchange Traded Funds (ETFs). They explain that “An ETF is a type of security that tracks an index, sector, commodity, or another asset, but which can be purchased or sold on a stock exchange the same as regular stock.”
The crucial part of the definition that we will discuss later is “a type of security that tracks.” This part of the definition is one of the significant differences between ETFs and mutual funds.
Like mutual funds, ETFs can contain various types of securities. But unlike mutual funds, they have an “associated price” that fluctuates throughout the day, which is why they can be bought and sold on all stock markets during market hours.
ETFs are typically passively managed, which means they are not actively controlled by a person but instead automated with little human supervision.
Investors like ETFs because they have more control over the investment since ETFs are traded throughout the day like stocks. ETFs also have fewer taxes and lower fees since most are passive management.
For example, there are no load fees, as is common with some mutual funds, and if you use a broker to buy or sell ETFs, the commission ranges from 0 to $20.
Mutual Funds
Mutual Funds are similar to ETFs because they are both a mix of different securities, which creates an easy way to diversify. The main difference is in the way they are managed.
Mutual funds have a funds manager who makes daily decisions regarding asset allocation. This type of management is called active management, and it is one thing that makes mutual funds so appealing, particularly for novice investors.
When an account is actively managed, a person is doing the research and analysis. Although Robo investors prove that these tasks can be automated, the human manager’s gut instinct or personal judgment cannot.
It is this personal touch that sets many mutual funds apart from other securities.
This active management approach makes fees higher, and mutual funds have several possible fees based on the type of fund. In general, the fund will either have annual fund operating expenses, which are ongoing fees, or shareholder fees, which involve one-time costs and sales commissions.
Mutual Funds and ETFs Moving Forward
As we know them, ETFs are relatively new, with one fund created in 1993 to more than 7,000 in 2020. They were created as an alternative to mutual funds and have achieved the desired purpose.
Though blamed for much of the market volatility, ETFs remain a popular investment vehicle for many, particularly young investors.
Americans like control and instant gratification, which is why many investors prefer exchange-traded investments. Even though mutual funds are not exchange-traded, ETFs are unlikely to replace mutual funds.
First, mutual funds benefit from being a substantial part of many retirement and pension funds, and many of those funds forbid investors from holding ETFs.
Second, ETFs are primarily passive management accounts, and many people, particularly older investors, still prefer actively managed funds.
Finally, there is always a fear with a security that can outprice its underlying asset, as ETFs can.
Many investors wonder how America ever lived without ETFs, and they are experiencing much success with this investment vehicle.
However, a good rule is to invest in what you can easily explain. Therefore, before investing in ETFs, reading the following Amazon books may help you get a clear picture of how mutual funds that are not exchange-traded and ETFs that are can both fit into your financial portfolio.
Education Materials To Consider
- Investing in ETFs for Dummies offers an essential guide to ETFs by discussing the risks and rewards and exposing how ETFs can fill gaps in your financial portfolio.
- The ETF Handbook is an incredible reference book that is designed for professional advisors. It discusses the key differences between ETFs and stocks and provides technical details for monitoring and analyzing ETFs.
- A Comprehensive Guide to Exchange-Traded Funds covers how ETFs work, how they are regulated, and how to use them strategically.
- The ETF Book All You Need to Know About Exchange-Traded Funds was written by a Chartered Financial Analyst (CFA) who provides a broad yet in-depth understanding of ETFs. This book is divided into chapters covering different types of ETFs and issues and strategies associated with this investment vehicle.
- The Truth About ETF Rotation is an interesting and educational read because it shares hypothetical strategies that could have helped double portfolios during the 2008 recession.
- The Ultimate ETF Guidebook begins with an overview of ETFs but then uses essays written by different authors to cover recent developments in this investment tool. The book ends with model portfolios showing readers how to build their own.
- ETFs for the Long Run provides novice investors with a clear understanding of ETFs and how to use them.
- Investing in ETFs for Beginners is actually two books in one. Nicolas Leonard seeks to show readers how to invest successfully even if you do not have large sums of money. He discusses the fundamentals of investing and how to allocate assets based on your age.
- ETF Investment Strategies: Best Practices from Leading Experts allow readers to learn strategies used by two top ETF investors. It shows you how ETFs work and how you can use them effectively.
Author’s Recommendations: Top Trading and Investment Resources To Consider
Before concluding this article, I wanted to share few trading and investment resources that I have vetted, with the help of 50+ consistently profitable traders, for you. I am confident that you will greatly benefit in your trading journey by considering one or more of these resources.
- Roadmap to Becoming a Consistently Profitable Trader: I surveyed 5000+ traders (and interviewed 50+ profitable traders) to create the best possible step by step trading guide for you. Read my article: ‘7 Proven Steps To Profitable Trading’ to learn about my findings from surveying 5000+ traders, and to learn how these learnings can be leveraged to your advantage.
- Best Broker For Trading Success: I reviewed 15+ brokers and discussed my findings with 50+ consistently profitable traders. Post all that assessment, the best all round broker that our collective minds picked was M1 Finance. If you are looking to open a brokerage account, choose M1 Finance. You just cannot go wrong with it! Click Here To Sign Up for M1 Finance Today!
- Best Trading Courses You Can Take For Free (or at extremely low cost): I reviewed 30+ trading courses to recommend you the best resource, and found Trading Strategies in Emerging Markets Specialization on Coursera to beat every other course on the market. Plus, if you complete this course within 7 days, it will cost you nothing and will be absolutely free! Click Here To Sign Up Today! (If you don’t find this course valuable, you can cancel anytime within the 7 days trial period and pay nothing.)
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Conclusion
Although mutual funds are not exchange-traded on any stock market, they remain a sound investment, particularly for long-term investors. Still, it is possible to get the same benefits of diversification with lower feeds by adding ETFs to your financial portfolio.
BEFORE YOU GO: Don’t forget to check out my latest article – ‘Exploring Social Trading: Community, Profit, and Collaboration’. I surveyed 1500+ traders to identify the impact social trading can have on your trading performance, and shared all my findings in this article. No matter where you are in your trading journey today, I am confident that you will find this article helpful!
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