Looking to invest in mutual funds or exchange-traded funds (ETFs)? If so, there are some fundamental differences between the two that you should know before you start. With benefits and risks to both, here’s what you need to know about mutual funds and ETFs.
A mutual fund is an investment vehicle (or product) that pools your money together with money from other investors with similar objectives for the purpose of investing in different types of securities. Mutual funds are handled by professional money managers, who invest with the goal of earning a return for the pool of fund and investors.
ETFs are funds that are made up of a basket of securities like stocks, bonds and other assets. ETFs trade like a stock and can be bought or sold during normal trading hours. This freedom to buy and sell is called intra-day trading.
Both mutual funds and ETFs are diversified investments, meaning as an investor, you can buy a basket of securities that are balanced to meet your overall investment objectives and risk threshold, making them lower risk investments.
Mutual funds and ETFs are different in a number of ways. However, the biggest distinction is that mutual funds trade only at the end of the day whereas ETFs have the freedom and benefit of intra-day trading.
Because mutual funds price once a day at their net asset value or NAV (the value of the underlying securities), you have limited control over the timing when you can trade the investment if stocks rise or fall – you get what you get at the end of the trading day. On the other hand, ETFs have the benefit of being moved during trading hours, creating an opportunity to take advantage of price fluctuations.
Another important difference and benefit of ETFs is they’re index-linked, which results in a lower expense ratio than mutual funds. The expense ratio reflects the costs associated with fund management. Most mutual funds aren’t index-linked and therefore actively managed, requiring analytics, research, etc., by money managers that account for a higher operational cost. However, this might just be a small price to pay to for help with your investment portfolio.
Like any investment, mutual funds and ETFs carry risk and reward potential. The value of mutual funds fluctuate with the price of the securities in the fund while carrying management fees that can impact your returns. And index-linked ETFs are at the mercy of a fluid stock market. That’s why it’s important to establish what your comfort level with risk is before you begin and speak to a wealth advisor to ensure you understand all the realities.
Mutual funds and ETFs can streamline the process of building a diversified portfolio. And there are many types of mutual funds and ETFs to invest in — from money market funds, fixed income funds, equity funds, and balanced funds to currency funds, real estate funds, commodity funds and speciality funds.
For new investors, this can all seem complex and even a bit intimidating. That’s why it’s best to sit down with a Northern wealth advisor to ask any questions, and explore what type of investments best suit your goals.