Exchange Traded Funds
Exchange-traded funds (ETFs) can be traded throughout the day, so you might see your ETF value fluctuating while trading is going on. When you buy an ETF, you’re buying it at the current market price. You can buy one or as many shares as you can afford at the current price. ETFs typically have lower expense ratios than most mutual funds. In theory, this can provide a slight edge in returns over index funds for the investor. For instance, the Vanguard S&P 500 ETF (VOO) has an expense ratio of 0.03%, while the mutual fund version, Admiral Shares (VFIAX), has expenses of 0.04%—although both have virtually the same performance numbers in terms of returns. ETFs are the newer version of funds created to democratize access to investments via lower fees compared to mutual funds. Fractional shares of investment vehicles also allow investors to buy a fraction of an ETF instead of a whole unit.
Mutual Funds
You can buy a mutual fund at any time of the day, but the fund’s managers cannot make trades within the fund until the end of the day. The price at which you buy or sell a mutual fund isn’t the price but the net asset value (NAV) of the stocks that make up the fund. When you invest in your mutual fund, your money is used for trading the fund’s NAV at the end of the trading day. For example, it’s common for mutual funds to have a minimum buy-in, such as $3,000. So if shares cost $100, you are buying 30 shares. Mutual funds can be either passively managed or actively managed, whereas very few actively managed ETFs are offered. ETFs are generally passively managed, which makes them most similar to index mutual funds. Mutual funds generally allow you to set up automatic investing because you give them a dollar amount that buys a certain number of shares.
Special Considerations
Both mutual funds and ETFs enable you to buy a basket of securities in one purchase. They both typically invest within a stated or implied objective, such as growth, value, or income. In addition, they will usually invest within a specific category of stocks or bonds, such as large-cap stocks, foreign stocks, or intermediate-term bonds. ETFs are the newer version of funds created to democratize access to investments through lower ETF prices and fees compared to mutual funds. The recent phenomenon of fractioning enabled by technology now allows buying a fraction of an ETF instead of a whole unit at the same title as stocks. You can use mutual funds and ETFs to achieve diversity in your portfolio. However, you can also use them both to complement each other. For example, some investors like to use ETFs for sector funds and mutual funds for actively managed choices. ETFs based on indexes are generally cheaper to buy, so you can buy into them if you’re limited on capital. For example, the Vanguard S&P 500 ETF (VOO) price was about $407 on Aug. 10, 2021, while the minimum for the mutual fund Admiral Shares (VFIAX) version of the same index is $3,000. Mutual funds sometimes use leverage, but leveraged index strategies pose extra risks for buy-and-hold investors, so many traders prefer the intra-day trading capabilities of ETFs.
