ETFs versus Mutual Funds - What You Need to Know

ETFs versus Mutual Funds

You may already have a mutual fund in some capacity as a lot of people even when they are first starting out in investing have invested in a mutual fund. A mutual fund is an investment program funded by shareholders that trades in diversified holdings and is professionally managed. An ETF or Exchange Traded fund on the other hand, is a type of kind of investment that consists of stocks, bonds or commodities.

Mutual Funds Require Professional Management

Mutual fund investing often involves a portfolio or the pooling together resources with other investors to purchase a collection of stocks, bonds, or other securities that might be hard to assemble on your own. The price of the mutual fund, also known as its net asset value (NAV), is determined by the total value of the securities in the portfolio, divided by the number of the fund’s outstanding shares.

As a military vet or serving personnel, you may not have invested a lot of time and energy into investment strategies as you are more concerned with immediate financial concerns and also your job consumes a lot of your time. Nonetheless, starting an investment plan for your future is important, even if you begin with a very small amount and work your way upwards as it fits.

ETFs Use Passive Management with Lower Fees

Investing in ETFs can be a great investment strategy for military personnel because your ETF portfolio is passively managed and does not require a fund manager like mutual funds. Therefore, you have lower lower operating costs compared to actively managed funds.

Passively managed funds like ETFs track a market index or benchmark automatically and therefore do not require a fund manager’s expertise and thus associated fees.

The fees you incur involve the purchase cost of the ETF and the commissions you pay when you buy or sell ETFs. The “bid ask spread” is the difference between the price at which you can buy shares of an ETF, and the price at which you can sell it. If you are an investor who trades often with large orders, you will want to pay attention to the bid-ask spread to make sure it is in alignment with what you are prepared to spend.

On the other hand with mutual funds, there are a variety of fees that may be associated with mutual funds. Some funds come with transaction charges known as loads or redemption fees, which are fees you pay to buy or sell shares in the fund.

ETFs Offer Greater Diversification:

Both mutual funds and ETFs track market indices like the S&P 500. While ETFs typically track a market index such as the S&P 500, there are other types of ETFs that aim to outperform the market, and yet others that offer exposure to niche market areas.

With an ETF, you can invest in a variety of different securities. They trade a lot like stocks as they can bought and sold at different prices from market open to market close. ETFs allow for a diversification of a mutual fund with the trading flexibility of a stock.

One of the principal benefits of ETFs is the opportunity to invest in a diversified portfolio of securities. This can be an effective way to make more targeted investment decisions. Whether you are interested in investing in gold or in solar energy or a tech company for example, there’s an ETF for that.

As ETFs invest in a portfolio of securities, investors can find them appealing and less time consuming than individually picking out stocks, which can also be more expensive and complex. As in all stock investment, you will want to do research to understand the investment approach of the ETF you are thinking of purchasing.

Flexible trading:

ETFs can be bought and sold at any time throughout the trading day like stocks. This can be an advantage in fast-moving markets. This offers more flexibility than mutual funds that are bought or sold based only on the net asset value (NAV) that is determined once per day, at the end of the trading day. Also ETFS have lower investment minimums, allowing you to buy as many or as little ETF shares as you wish. The price you buy an ETF varies like a stock share and is affected by supply and demand. ETFs can trade at a premium or market price above or a discount or market price below the NAV. You must pay attention when you buy and sell ETFs so you are aware of risks involved.

Mutual funds also offer flexible trading. All mutual funds allow you to buy or sell your fund shares once a day at the close of the market at the fund’s NAV. You can also automatically reinvest income from dividends and capital gain distributions or make additional investments at any time.

Transparency:

While mutual funds only publish their securities that make up the fund once every 1 to 3months, ETFs report individual holdings daily. This transparency helps you see exactly what you own at any given time. This can help you identify any gaps and/or overlap in your portfolio.

Tax efficiency:

Both mutual funds and ETFs are required to pay capital gains to shareholders annually, but ETFs have lower trading activity as they track indices, leading to fewer capital gains than actively managed mutual funds. ETFs can be traded based on supply and demand or “creation and redemption,” leading to greater tax efficiency.

While mutual funds can generate dividend income, they are also subject to several tax fees. Investors who own mutual funds that are not held within an IRA or another tax-advantaged account may be subject to three different types of taxes:

- Dividend income, which is generally taxed at your ordinary income tax rate.

- Capital gains from the sale of securities, which can be taxed at your ordinary income tax rate or the more favorable long-term capital gains rate, depending on how long the securities were held by the fund.

- Capital gains when you sell or exchange shares of the fund at a profit. Those capital gains could also be taxed at your ordinary income tax rate or the more favorable long-term capital gains rate, depending on how long you held those shares.

There are more than 1,400 ETFs available today. It is important that you understand the costs, risks and advantages of the ETFs you choose to invest in.