Mutual Funds vs. ETFs

by : Terry Parker

Mutual funds are a traditional component of most investors portfolios, but exchanged traded funds, or ETFs, have been gaining popularity over the past decade as well. In recent years, more investors, brokers, and financial advisors have been using ETFs, and they have been included in many company retirement plans. The security, as well as the traditional aspect of mutual funds, and their stable reputation, however, still carry a wide appeal for many investors. This article can help you determine which type of fund is best for you and your investment options.

Like traditional mutual funds, ETFs contain many securities, or stocks and bonds. The difference between these and mutual funds lies chiefly in the way that investors can buy and sell shares, since when ETF investors wish to redeem their fund shares, they are required to trade with other market investors, and this requires the use of a broker who can help you decide which option is a better fit.

Exchange traded funds are both priced and traded on an exchange, either, the American Stock Exchange, the New York Stock Exchange, or the Nasdaq, throughout the course of the business day in the same manner as stocks. Traditional mutual fund prices are set once a day, and investors are required to place their orders before a certain time in order to get the price of the day. With ETFs, unlike mutual funds you can use these funds the same way that you would a share of stock, including setting market and limit orders, buying on margin, and shorting.

Since ETFs must be traded with other market participants, ETFs generally have two prices the net value, or NAV, which is determined on a daily basis based on the ending value of both its portfolio and accrued expenses, and its share price, which is determined by the ETFs supply and demand profile in the market.

Although ETFs are not immune from taxes, the good news is that they are structured to enable investors to shield themselves from capital gains better than they would with conventional funds. Since ETFs are index funds, they typically trade at a lower value than most actively managed funds and in most cases, should generate fewer capital gains. And since most investors frequently buy and sell shares of ETFs with other investors, the ETF manager does not have to worry about selling holdings, which can trigger capital gains, in order to meet investor redemptions.