Difference between an ETF and a mutual fund

Introduction

Investing in the stock market has become a popular way of earning money. Two common ways of investing are through exchange-traded funds (ETFs) and mutual funds. Both ETFs and mutual funds carry their own sets of advantages and disadvantages. Understanding these differences can help investors make informed decisions when it comes to choosing which investment product to use.

Ownership structure

The ownership structure of ETFs and mutual funds differs significantly. Mutual funds are operated as open-end investment companies which means the investors purchase shares in the fund from the company at the fund’s net asset value (NAV). The NAV is calculated by using the total value of all the securities in the fund divided by the total number of outstanding shares.

In contrast, ETFs are investment products that trade on a stock exchange like stocks. An ETF has an underlying basket of securities, and the price of the ETF is based on the value of the underlying securities. ETFs can be traded throughout the trading day, similar to buying and selling stocks on the exchange.

Fees

The fees associated with mutual funds and ETFs vary. Mutual funds tend to have higher expense ratios than ETFs. The expense ratio is the total amount of fees charged by the investment company which includes the cost of management, administrative, and other fees. This fee is generally calculated as a percentage of the fund’s NAV.

The fees for purchasing and selling ETFs predictably are relatively low when compared to mutual funds. Most brokerages allow a person to buy and sell ETFs without any fees which can result in significant savings for an investor, particularly for those that trade frequently.

Tax implications

ETFs and mutual funds differ in their tax implications. When an investor buys or sells shares in a mutual fund, he or she is essentially buying or selling securities within the fund, which triggers a taxable event. Moreover, the investor is required to pay taxes on capital gains, even if the individual chose not to sell the shares.

ETFs, on the other hand, are not as tax-inefficient. Since investors trade ETFs on the stock exchange, they only face capital gains or losses when the shares are sold. Also, ETFs that are based on an index never have to sell shares until there is a change in the underlying index. This leads to fewer taxable events and more opportunities to delay taxation.

Diversification

Both mutual funds and ETFs help investors gain access to a diversified set of investments. Mutual funds generally offer greater diversification opportunities since they can invest in a wide range of assets. Mutual funds also provide investors with the ability to participate in a broad range of investment styles, geographies, and industries.

ETFs can offer unique diversification opportunities since they can invest in almost anything traded on an exchange, including stocks, bonds, currencies, and commodities. Moreover, ETFs can be used to invest in specific sectors or countries.

Conclusion

While ETFs and mutual funds share similarities in certain areas, they each have their own distinct differences when it comes to ownership structure, fees, tax implications, and diversification. Investors should conduct a thorough analysis of their investment needs before choosing the type of investment product that’s suitable for them. By understanding the key differences between ETFs and mutual funds, investors can make informed decisions that can help them achieve their investment objectives.

Table difference between an etf and a mutual fund

ETF vs Mutual Fund

Below is a comparison table between ETF and Mutual Fund.

Feature	ETF	Mutual Fund
Management Style	Passive or Active	Mostly Active
Stocks/Bonds Basket	Trades on an exchange and tracks an index or sector	Diversified and managed by professional managers
Trading	Traded like individual stocks throughout the day	Traded only once a day, after the market closes
Transaction Fees	Lower fees due to its structure of trading on the exchange	Higher fees due to higher management costs and trading fees
Minimum Investment	Lower minimum investment than mutual funds	High minimum investment amount
Redemption	Can be sold short, and the redemption process is tax efficient	No short-selling option, and tax inefficiencies might cost investors