A:

Exchange-traded funds, or ETFs, are similar to mutual funds because both instruments bundle together securities in order to offer investors diversified portfolios. Typically over 100, or even up to 3,000 different securities can make up a fund. Yet, the two investment types are marked by significant differences.

ETFs trade throughout the trading day, like a stocks, while mutual funds trade only at the end of the day at the net asset value (NAV) price. Most ETFs track to a particular index and therefore have lower operating expenses than actively invested mutual funds. Thus, ETFs improve your rate of return on investments. In addition, ETFs have no investment minimums or sales loads, unlike traditional mutual funds, which have both. However, most indexed mutual funds will not have sales loads.

ETFs create and redeem shares with in-kind transactions that are not considered sales. Thus, taxable events are not triggered. Redemptions create tax events in mutual funds, but they do not create tax events in ETFs. When a forced sale of stock occurs, mutual funds record and distribute higher levels of capital gains than ETFs. In addition, ETFs have greater tax efficiency due to a structure that allows them to substantially decrease or avoid capital gains distributions altogether. This difference can greatly affect the overall rate of return, even if an ETF and mutual fund both track the identical index.




ETFs
Mutual Funds

Trade during trading day
Trade at closing NAV

Low operating expenses
Operating expenses vary

No investment minimums
Most have investment minimums

Tax-efficient
Less tax-efficient

No sales loads
May have sales load


For more on this topic, read Exchange-Traded Funds: Introduction and Mutual Fund or ETF: Which Is Right for You?

This question was answered by Steven Merkel.

RELATED FAQS

  1. Does index trading increase market vulnerability?

    Learn how the rise in popularity of passive ETFs and mutual funds tracking indexes has increased the correlation among stocks, ...
  2. What does a high turnover ratio signify for an investment fund?

    Find out more about the turnover ratio, what the turnover ratio measures and what a high turnover ratio indicates about an ...
  3. What is the difference between passive and active asset management?

    Find out about active asset management, passive asset management, how these strategies are utilized and the differences between ...
  4. Is there a situation in which wash trading is legal?

    Learn about what wash trading is and how it can affect the value of a stock. Explore the difference between wash trading ...
RELATED TERMS
  1. Exchange-Traded Mutual Funds (ETMF)

    Investopedia explains the definition of exchange-traded mutual ...
  2. Dividend

    A distribution of a portion of a company's earnings, decided ...
  3. Sharpe Ratio

    A ratio developed by Nobel laureate William F. Sharpe to measure ...
  4. Exchange-Traded Fund (ETF)

    A security that tracks an index, a commodity or a basket of assets ...
  5. Historic Pricing

    A method for calculating the value of an asset using the last ...
  6. Lion economies

    A nickname given to Africa's growing economies.

You May Also Like

Related Articles
  1. Mutual Funds & ETFs

    ETF Analysis: SPDR S&P 500 Trust

  2. Investing Basics

    Bitcoin ETFs: How Do They Work?

  3. Mutual Funds & ETFs

    ETF Analysis: Energy Select Sector SPDR

  4. Economics

    What to Expect from Russia's Oil-Dependent ...

  5. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI Singapore

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!