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Exchange-traded funds (ETFs) and mutual funds are both popular tools for investing. To a novice observer, they may not be easily distinguished — they each pool investor money and can potentially provide diversification through a single investment.
They are similar in both structure and purpose, but there are differences within the details. The fund that best suits your investment strategy will depend on your overall financial goals. So, what's the difference between an ETF and a mutual fund?
What Is an ETF?
An ETF is a group of investments combined into a single investment vehicle. ETFs might contain numerous stocks, bonds or other investments, and ETFs are traded on stock exchanges. Like individual stocks, you can buy and sell shares during market hours.
What Is a Mutual Fund?
A mutual fund is another shared investment portfolio that, like an ETF, combines assets from a variety of investors. When you buy a mutual fund, you buy shares from the investment company, and you become a partial owner of a large pool investments. Mutual funds typically have an investment objective, and they may own a large number of stocks, bonds or other underlying investments.
ETFs vs. Mutual Funds: Key Similarities & Differences
What's the difference between an ETF and a mutual fund, and how are they similar? Here's a look at several key features that are different between these two types of investments, as well as some of their similarities.
Trading
When you invest in a mutual fund, you are transacting directly with the fund. With ETFs, on the other hand, you are trading on the secondary market. In some cases, the market price may be more or less than the value of the underlying investments. You can trade ETFs throughout the day during market hours, but mutual fund trades only take place after the market closes.
Fees
Internal costs vary widely from fund to fund, but in most cases, ETFs are not necessarily any more or less expensive than mutual funds. Both ETFs and mutual funds can be relatively inexpensive, but that's not always the case. Costs typically depend on the fund company, the fund objective and other factors.
Trading costs might also differ between them, depending on where you invest. Consider discussing your goals with a financial professional.
Investment Exposure
ETFs and mutual funds can both employ a variety of investment objectives. With either investment vehicle, you can decide whether to focus on broad market exposure or a narrower realm of investments.
For example, you might invest in funds that provide exposure to companies in the U.S., corporate bonds or a broadly diversified portfolio combining stocks, bonds and overseas investments.
Risk
The risk you take depends on the fund's investment objective and the underlying investments the fund holds, so it's critical to understand how your investment works before investing. However, a mutual fund does not necessarily carry more or less risk than an ETF. Always read a mutual fund or ETF prospectus for important details.
Although you can diversify your money with both mutual funds and ETFs, diversification does not eliminate risk, and you can lose money in either type of investment.
Taxes
When you sell mutual funds or ETFs in a taxable account, you generally owe taxes on any gains you realize. Also, when an ETF or mutual fund pays a dividend or realizes a gain, those earnings may be passed through to you — with potential tax consequences. However, in limited circumstances, an ETF could potentially pass through less income.
Consider discussing your situation with a financial professional to determine how different investments might affect your tax return.
Should You Invest in a Mutual Fund or ETF?
In many ways, ETFs and mutual funds are comparable. They both can allow you to spread your money among a diverse mix of underlying investments. You can invest in specific sectors, or you can use a single investment to spread your assets among stocks, bonds and cash.
Ask your investment provider (and read the prospectus) to learn about the fees and expenses of any investment you're considering. The best option for you depends on your needs and goals, and either approach might be right for you.
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