General Finance

What is the Difference Between Mutual Funds and ETFs?

Looking to invest your money but not sure what the differences are between mutual funds and EFTs? Both options can be great investment vehicles for investors to have in their portfolios or retirement funds. Both have advantages and disadvantages, so make sure you know enough about both of them before you decide to invest your hard earned cash.
What Are Mutual Funds?
A mutual fund is a portfolio of mixed investments that are managed by a mutual fund manager. These pools of investments are shared by large groups of people who invest in them. An important note here is that these people don’t have control of the investments that are in the portfolio – that’s the job of the mutual fund manager.
When you buy a mutual fund, you are buying a share of the fund. This should not be confused with stock shares, since you do not have the voting right that you would with stock shares. The mutual fund manager(s) control the investments from within – you are just along for the ride. Dividends and interest earned on the investments made throughout the year are held and given to the shareholders of the mutual fund as “distributions”. When the fund sells shares and takes capital gains, they may also pass these as “distributions” to the mutual fund shareholder. If the investment holdings increase in a mutual fund but they do not sell, they raise the mutual fund share price. Distributions can be taken by the mutual fund holder as income or reinvested to buy more mutual fund shares.
Pros
·       They are often diversified, which spreads the risk of the investment.
·       They are professionally managed by a skilled manager that will make you good returns – hopefully!
·       They are simple and allow you to choose from a variety of options.
Cons
·      they will cost more because they’re managed.
·       Cost within these funds can really add up and eat away at profits.
·       Liquidity is not instantaneous, meaning it could take some time for you to get your money converted to cash.
What are ETFs?
Exchange-Traded Funds (ETFs) have been around since the late 1980s and gained popularity when people started looking for good alternatives to mutual funds. ETFs are great sources for people who want their money to be tied to an index or tied to a specific market or exchange like the S&P500. ETFs trade frequently in the market just like stocks. The ETF owns all of the investments in the portfolio, such as stocks, bonds, gold bars, oil futures, etc. The ETF also divides ownership among the ETF shareholders. Shareholders are entitled to dividends and may also get residual value if the fund is liquidated.
Pros
·       Automatically follows a market and gets great diversification.
·       They have high liquidity and are exchanged like stocks.
·       They also have low fees.
Cons
·       Follows market closely; so if the market goes down, it can go down as well.
·       Dividends are reinvested instantly. (This could be good or bad)
·       The bid to ask price spread can be really big.
Bottom line
Both of these investment vehicles are great for wide and diversified exposure to the investing world. The easiest way to distinguish mutual funds from ETFs is the fact mutual funds are managed with a certain goal and ETFs are designed to follow an index. Each of these investment vehicles has its ups and down. If you are looking for more liquidity, I would go with the ETF. ETFs also tend to be more cost-efficient. If you are looking to have a well-managed investment vehicle, go with the mutual fund – just make sure it has a good fund manager. I personally like ETFs, but I do have some mutual funds in my portfolio since I’m willing to pay a little extra for a well-managed fund. Make sure you are always doing your research! Check out Common Sense on Mutual Funds by John C. Bogle and The ETF Book by Richard A Ferri. Just know that any amount to start with is better than putting it off or not starting at all. Time is your biggest asset! There is a great Chinese proverb that goes like this: “The best time to plant a tree was 20 years ago. The second best time is now.”

 

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