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Difference between ETF and Mutual Funds

ETF vs Mutual Funds

When comparing exchange traded funds, Understanding the way that both funds work will be the key to determining which one best suits your strategy for investing. Before you can reach a decision, you need to know what exactly your goals are in investing. What kind of risks are you capable of handling? What asset classes do you want to be exposed to? It's easier to select an investment tool when you already have parameters set up. Once you know your investment needs, you'll be able to properly decide which of an ETF versus mutual fund is right for you.

ETF and Mutual Fund Breakdown

If you're a novice investor going about things in the traditional way, reallocating strategically, you might enjoy how simple a fund can be. While ETFs are known for their accessibility as well, they are more for those who would take the power of being able to trade their shares throughout the day, much like a regular stock. The lower expense ratio of an ETF and the immediacy with which they can be traded at is often used as leverage by institutional investors for directional bets and hedge investments. Mutual funds are traded during Wall Street's hours, but the actual transition won't occur until the market has closed. The price of a fund is found by calculating the sum of the stock prices within the fund.

The Downside of ETFs

In the battle of ETFs against funds, dollar-cost averaging investors will begin to note how expensive ETFs can become due to brokerage fees. A way to preserve money, in the long run, is to invest in a buy-and-hold ETF, but conversely, this exposes investors to something called tracking error. While ETFs are classified as a type of fund, making them liable to the Securities and Exchange Commission's regulations, they are more complex in their structure and are under the influence of more rules than funds. Trading well with ETFs makes it important that an investor is well-versed in index funds, as that is what ETFs are largely made out of.

Choosing Between ETFs and Mutual Funds

These situations are just a few of the variables that you should take into consideration when deciding on an ETF vs mutual fund. You have a large number of choices available to you, and by deciding on your preferred amount of exposure, you can slim your options down to only the best for you.

    Let us examine different characteristics of these two investment options:
  • The process of trading: Great versatility is offered by ETFs. The idea is that an investor can buy or sell his Exchange Traded Funds at any time of the trading day. However, in the case of traditional mutual funds, the investor has to wait until the end of the trading day to do the transaction. Also, in the case of mutual funds, this transaction can only take place once in one trading day, however, in the case of Exchange Traded Funds; the investors enjoy the capability of doing transaction as per their wish during a trading day. Transaction in mutual funds is limited to happen at the end of the day as it is then that the Net Asset Value of the mutual funds is determined. In the case of ETF, the transactions are short and can be multiple in a day. This is because they are continuously valued in the market.
  • Operational Expenses: Internal or operation costs of most of the Exchange Traded Funds are considerably low if we compare them with the operating costs incurred on mutual funds.
  • Advantages and Disadvantages in Tax Scenario: Investors get attractive tax benefits from them. ETFs tends to realize fewer capital gains as correlated with mutual funds. Exchange Traded Funds have more tax benefits as compared to mutual funds due to the way in which they are formed and then redeemed.

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