Both Mutual funds and ETFs are basket of individual stocks, however, ETFs are actually a hybrid between mutual funds and stocks, with a main caveat that one can buy or sell ETFs throughout the trading day unlike mutual funds that only trade once after stock market closes.
As both Mutual Funds and ETFs are basket of individual stocks or bonds, they are overall considered safer investments than individual entities. There really is no substantial difference between the two if you are investing for long-term time frame. However, there are some fundamental differences between the two as noted below.
Trading Time
ETF can be bought or sold at any time while stock market is open. If you are looking for a precise entry and exit time-point then ETF are better than mutual funds which can only be traded after stock market closes.
Fluctuating Price
ETF prices fluctuates throughout the time stock market is open. If you are looking for a precise entry and exit price-point then ETF are better than mutual funds which can only be traded after stock market closes.
Choice Flexibility
Mutual Funds have much longer history and provide lot more choices to invest than ETFs. However, ETFs are becoming increasing popular lately.
Fees Impact
ETFs generally have lower management fees compared to mutual funds. A small difference in fees can have huge impact for those investing for long-term time horizon.
Periodic Returns
Mutual funds generally provide returns (profit) in the form of capital gains and dividends. ETF on the other hand provide returns mainly on dividends.
Tax Implications
ETFs are considered more tax efficient than Mutual funds. Mutual funds generally have more transactions (buying and selling shares) that may result in capital gains that are taxable, even for those who may not have performed such transactions. Thus it is preferable to invest in ETFs in a taxable account and Mutual funds in tax-friendly accounts like 401k, IRA and Roth IRA.
Advance Trading Techniques
ETFs can be purchased on margin or sold short. These are advanced trading techniques that have unique risks and thus are not recommended for beginners.
Final Verdict
Though both Mutual Funds and ETFs investment is considered safer than individual company stock or bond investment, there are fine differences between the two. Make sure you discuss your financial situation with a registered financial advisor before making any investment decision.
We hope the information in this post will be helpful in your journey of aspiring nirvana!