October 30, 2017
Did You Know There Are A Few Subtle, Yet Key Differences Between Mutual Funds and Exchange Traded Funds (ETFs)?
The Value of Pooled Investment is Diversification
Both mutual funds and Exchange Traded Funds (ETFs) provide diversification benefits to investors because they invest in a basket of securities rather than a single position.
There are both low-fee, passive mutual funds and ETFs that track an index. In addition, there are actively managed ETFs and mutual funds, which charge higher expense ratios due to their active management.
How Mutual Funds and ETFs Trade
This is where the similarities end. Mutual funds are priced and traded at the close of the trading day and are based on the closing values of all securities in the fund. In contrast, ETFs are openly traded throughout the day, and as a result, their values fluctuate as the trading day progresses. This characteristic gives investors the flexibility to move in and out of ETFs, an advantage they do not have with mutual funds.
In addition, while ETF prices can deviate from the value of the underlying securities held in the fund, mutual funds cannot. Because of this flexibility, the number of different ETFs has grown substantially in recent years. Between 2001 and 2014, the number of ETFs climbed from 102 to 1,375 (per the trade association for the mutual fund industry, the Investment Company Institute).
ETFs Can Be More Tax-Efficient
ETFs are also more tax-efficient than mutual funds. At the end of the year, mutual funds are required to distribute all taxable gains that are generated by annual trading activity. Even if the fund strategy does not involve significant trading, the act of redeeming shares for outgoing investors can force fund managers to sell positions in the fund and generate taxable gains.
ETFs, on the other hand, do not normally generate such capital gains. Therefore, the potential capital gains exposure of a mutual fund is an important metric when assessing the fund’s value. These tax concerns are not relevant except when investing inside of a tax-deferred retirement vehicle such as a 401(k) or an IRA.
If you have any questions about which investment vehicle will best suit your needs, please reach out to your advisor to further explore the differences between mutual funds and ETFs.
This material is a general opinion and provides general information compiled by the Firm from sources believed to be reliable at the time of this material being distributed. The opinions or views expressed in this material are not intended to be financial, legal, or tax advice and may change without notice. Clients should always seek advice regarding their particular accounts and transactions from their financial advisor before making investment decisions. All investments involve risk. Past results do not guarantee future performance. There is no guarantee that any investment will return a particular performance result or a better performance result over another investment option.
There is no guarantee that a diversified portfolio will out perform a non-diversified portfolio in any given market environment. It is a method used to manage investment risk.
Jason Mishaw, MSF
As an associate wealth manager at Willis Johnson & Associates, Jason Mishaw is actively involved in both the Financial Planning role and the Investment Management role. On the financial planning side, he helps to implement customized financial plans for WJA clients. On the Investment Management side, under the supervision of a Senior Wealth Manager, he assesses the financial goals of WJA clients and assists in creating a customized strategy to further those goals.
Jason received a Master of Science in Finance at the University of Houston C.T. Bauer College of Business, a B.A. in economics and a B.S. in biochemistry and cell biology from Rice University.