ETFs vs. Mutual Funds: What’s the Difference?

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January 29 2019

With the average American’s life expectancy hovering around 80 years of age these days, and medical and health advances increasing all the time, it’s wise to have a financial plan in place that will see you through your twilight years in comfort, and the sooner you start, the better.  While most working adults contribute to 401K plans and some even go above and beyond to start IRAs or investment portfolios, the average person simply might not know how to safely invest their hard-earned money to save for retirement.

There are two great options to consider for those who are risk-averse when it comes to investment opportunities: ETFs and mutual funds.  What are these savings and investment vehicles?  What benefits can they offer and how do they differ?  Here’s what you need to know so you can choose the best financial planning route for your needs and preferences.

What are ETFs?

ETFs, or exchange-traded funds, consist of a grouping, or basket, of securities that is bought and sold simultaneously, rather than separately.  They are traded much like company stocks on the stock exchange, although they differ in a few key ways.

ETFs have a ticker symbol, like company stocks, which means they can be bought and sold on the stock exchange in much the same way.  The main difference has to do with the number and relative fluidity of shares in an ETF.  Whereas a company has to go through certain protocols to create new shares, the number of shares in an ETF can fluctuate daily as new investors buy in and are issued shares or current investors redeem their shares.

ETFs in their current form have been around since the early ‘90s and they are desirable for individual investors because of their innovative structures, flexibility in terms of trading, and opportunities to control when you pay capital gains tax for the greatest personal benefit.

There are several types of ETFs, including:

  • Actively Managed ETFs
  • Alternative Investment ETFs
  • Bond ETFs
  • Commodity ETFs
  • Exchange-Traded Notes
  • Foreign Market ETFs
  • Inverse ETFs
  • Market ETFs
  • Sector and Industry ETFs
  • Style ETFs

While ETFs have many advantages, including a wide variety of order types (limit, stop-loss, etc.) and the option to buy and sell any time, not just during market hours, there are also some potential drawbacks to be aware of.  Generally speaking, there are lower fees (no sales load, as with mutual funds), but for those who engage in frequent, small trades, the brokerage fees could become cost-prohibitive.

You also have to be careful to be aware of bid/ask spreads that could expose you to situations where you’re buying high and selling low.  Don’t forget, settlement dates for ETFs are two days after transactions are made, which could impact speedy access to funds for the purposes of reinvestment.

Whether you’re interested in traditional, alternative, foreign, or other markets, ETFs provide a great opportunity to diversify and manage your risk tolerance with relative ease.  When you work with a reliable financial advisor, you can utilize ETFs to take advantage of short-term market swings and contribute to your long-term financial planning goals.

What are Mutual Funds?

If you are at all familiar with the investment market, you’ve probably heard of mutual funds, even if you’re not entirely sure what they are.  Similar to ETFs, mutual funds revolve around a portfolio of carefully curated stocks, bonds, and other securities that are managed by portfolio managers working with researchers to make the best investment decisions on your behalf.

Mutual funds work by leveraging funding from a group of investors to gain access to desirable securities that the average investor would not be able to purchase alone.  Mutual funds are generally considered to be part of a long-term investment strategy because they tend to be low-risk and their performance may not prove very exciting in the short-term.  Over time, however, with solid management, investors could see significant returns.

There are several potential benefits to investing in mutual funds.  Like ETFs, they provide the average investor with the opportunity to diversify.  Many mutual funds feature upwards of a hundred different securities.  They also don’t tend to require a very large investment to get started.  Although there are usually minimums for buy-in, these could be waived, along with some fees, for certain types of investment, such as from a retirement account or with a schedule of automatic, recurring investments.

Another benefit is the ministrations of a professional fund manager, ostensibly an expert in this type of investment.  With proper research and analysis, fund managers select the portfolio of securities and choose when to buy and sell for the greatest potential profit in the long term, with minimal loss.  As an investor, you’ll also enjoy relative liquidity, as you have the opportunity to buy and sell shares in the fund daily.

You should be aware that mutual funds don’t offer the same tax advantages as ETFs.  You can be taxed on periodic distributions of dividends, as well as capital gains when you trade or sell shares in the fund at a profit, although the rate may depend on how long you hold shares.  One way to get around this is to hold mutual funds in tax-advantaged accounts (like an IRA or other retirement account).

Which is Right for You?

There are potential benefits and drawbacks to consider with both mutual funds and ETFs.  Both make for good long-term investments, so plan to stay for a while either way.  If your investments are not in a tax-advantaged account, ETFs offer more flexibility and better control over potential taxation.  If you’re using a tax-advantaged account for retirement purposes and your goal is to reinvest earnings, mutual funds offer easy reinvestment opportunities.

Even when you have a basic understanding of the differences between ETFs and mutual funds, it can be difficult to figure out which option offers the greatest personal advantages and helps you reach your financial goals.  With assistance from experienced financial advisors, you’ll get the expert guidance you need to make informed decisions about your financial future.

Contact the caring and qualified professionals at Dechtman Wealth Management today at 303-741-9772 or online to learn more.