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As more Americans take a hands-on approach to their finances, many are unsure whether to invest in exchange-traded funds (ETFs) or mutual funds.
Both offer a simple way to build a diversified portfolio of stocks or bonds, and in essence the two investment vehicles are very similar. But key differences – including how they are traded and how they are taxed – could determine long-term returns, experts say.
ETFs can trade at slight premiums or discounts to the value of their underlying investments. (Spencer Platt/Getty Images)
WHAT ARE ACTIVE ETFS AND HOW WILL THEY CHANGE HOW AMERICANS INVEST?
While ETFs trade on stock exchanges all day long – just like stocks – with prices fluctuating in real time, mutual funds are priced once a day after the market closes.
Because of that structure, ETFs can trade at slight premiums or discounts to the value of their underlying investments, although Sotiroff noted that the difference is typically “very small and insignificant.”
Taxes are another important consideration.
ETFs use a structure that allows many transactions, such as rebalancing, to occur without causing taxable capital gains. Mutual funds, on the other hand, can distribute these gains to investors in the year they are realized, Kellert and Sotiroff said.
A BEGINNER-FRIENDLY ETF PORTFOLIO THAT REQUIRES ALMOST NO MAINTENANCE AND DELIVERS LONG-TERM RESULTS
ETFs trade on exchanges throughout the day, while mutual funds are priced once a day after the market closes. (Lilli Förter/photo alliance via Getty Images)
“Overall, ETFs are more tax efficient than mutual funds,” Sotiroff said. “ETF investors will still have to pay capital gains taxes when they sell their shares, so ETF investors are essentially deferring capital gains rather than avoiding them. The benefit is that ETF investors can choose when to realize those gains, while mutual fund investors have less control.”
Will Rhind, CEO of GraniteShares, described ETFs as a “new technology” compared to the “old technology” of mutual funds.
Unlike many mutual funds, which require a minimum investment of $1,000 or more, ETFs can often be purchased for the price of a single share or even a fraction of one, according to Rhind.
CAN S&P 500 ETFS ALONE FUND YOUR ENTIRE RETIREMENT?
Taxes are another important consideration when choosing between ETFs and mutual funds. (iStock)
However, experts say the choice between ETFs and mutual funds ultimately depends on the investor.
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Kellert added: “The most important thing is not the packaging, but whether the fund fits an investor’s objectives, time horizon and comfort level. When used carefully, both ETFs and mutual funds can play an important role in a well-diversified portfolio.”
