Choosing between Exchange Traded Fund and Mutual Fund is difficult. The reason is that very few people actually know the difference between the two funds. These differences will affect the amount of money you invest. It will also influence your investment decision. This article we delve into the difference between the two funds and how you can take advantage of them.
Both ETF and mutual funds can hold a combination of bonds and stock. Also, they both can invest in precious metals and commodities. They must adhere to rules governing what they can actually own and how much they can invest in holdings. The two funds must follow the rules about the amount of money they can borrow based on the size of their portfolio.
ETFs trade like stocks. They trade whenever a buyer places an order. Mutual funds only execute at the end of each trading day. ETF trade on exchanges the same way the stock exchanges do. You trade an ETF with another investor and not a fund manager as it is in the case of mutual funds. It means that you have the freedom to buy and sell your shares at any time you might trade a stock. You don’t have to wait until the day ends as it is the case for mutual funds
Placing an Order
If you chose to trade in mutual funds shares, trade execution will take place at the end of the trading day. The figure for calculation of the net asset value will be available at 6 p.m. after the market closes. Some mutual funds charge a penalty for short-term holdings. The share class you purchase is the prime determinant of the penalty you pay.
For ETFs, there is no restriction on the holding period. It means that you will not incur a penalty even if you sell your asset minutes after you buy it.
Cost of Running
Mutual funds have two fee categories: annual expenses and sales charges (a load). A load is the commission paid to the broker. The fund recovers the fee from the investment at the point of buying or selling the asset. Note that not all funds charge sales fee (loads). All Mutual Funds charge an annual expense to cover their day to day operating costs. They charge 12b-1fees (distribution and service fees) management fees and administrative expenses fees. The expenses are, subtracted from your investment before calculating the returns. ETFs never have a load. The expenses for running an ETF are handled the same way as mutual funds.
Increasing and Reducing Outstanding Shares
Notice that both ETFs and Mutual funds can increase or reduce the number of outstanding shares. The demand and supply dictate all this. But there is a difference in the reasons and the way they do it.
When it comes to taxation, the ETF structure allows the fund to enjoy tax efficiency. This is not the case to investors in mutual funds. Since ETF engages in less trading activities, it creates fewer taxable activities. But the mutual funds distribute taxable gains to all the shareholders. Even those who choose to hold on their share, they must pay tax on the profits. For an ETF portfolio, it’s only when you sell the share that you generate a taxable issue.