Mutual Funds vs. ETFsSubmitted by Kaizen Financial Advisors, LLC on September 13th, 2019
The growth of exchange-traded funds (ETFs) has been explosive. In 1998, there were only 29; at the end of 2018, there were over 1,900 investing in a wide range of stocks, bonds, and other securities and instruments.1
At first glance, ETFs have a lot in common with mutual funds. Both offer shares in a pool of investments designed to pursue a specific investment goal. And both manage costs and may offer some degree of diversification, depending on their investment objective. Diversification is an approach to help manage investment risk. It does not eliminate the risk of loss if security prices decline.
Structural Differences. Mutual funds accumulate a pool of money that is then invested to pursue the objectives stated in the fund’s prospectus. The resulting collection of stocks, bonds, and other securities is professionally managed by an investment company.
ETFs work in reverse. An investment company creates a new company, into which it moves a block of shares to pursue a specific investment objective. For example, an investment company may move a block of shares to track performance of the Standard & Poor’s 500. The investment company then sells shares in this new company.
ETFs trade like stocks and are listed on stock exchanges and sold by broker-dealers. The price of an ETF is determined continuously throughout the day. It fluctuates based on investor interest in the security and may trade at a “premium” or a “discount” to the underlying assets that comprise the ETF. Most mutual funds are priced at the end of the trading day. So, no matter when you buy a share during the trading day, its price will be determined when most U.S. stock exchanges typically close.
Mutual funds, on the other hand, are not listed on stock exchanges and can be bought and sold through a variety of other channels — including financial advisors, brokerage firms, and directly from fund companies.
Tax Efficiency. There are tax differences as well. Since most mutual funds trade securities to facilitate liquidity, they are more likely to incur capital gains which are distributed to shareholders. Due to their operating structure, ETFs rarely experience capital gains distributions. Thus, ETFs tend to be the more tax efficient vehicle.
Operational Costs. Trading securities within a fund, both for mutual funds and ETFs, generates operational costs. Trading costs are paid out of investor funds and thus reduces fund performance. Due the structural differences discussed above; mutual funds tend to trade more than ETFs. This difference in relative trading activity tends to make ETFs less expensive to own.
Determining whether an ETF or a mutual fund is appropriate for your portfolio requires knowledge of how both investments operate. Despite the apparent cost advantage of ETFs, there are applications that favor mutual funds over ETFs.
At Kaizen, we tend to favor ETFs for their low costs and tax efficiency, but we also recognize where mutual funds logically fit into a portfolio. If you or someone you know have questions about building a portfolio with ETFs or managing capital gains efficiently, please reach out to a Kaizen Advisor. We can help you build the right portfolio to match your financial goals.
This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note - investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.
Mutual funds and exchange-traded funds are sold only by prospectus. Please consider the charges, risks, expenses, and investment objectives carefully before investing. A prospectus containing this and other information about the investment company can be obtained from your financial professional. Read it carefully before you invest or send money.
The Standard & Poor’s 500 Composite Index is an unmanaged index that is generally considered representative of the U.S. stock market. Index performance is not indicative of the past performance of a particular investment. Past performance does not guarantee future results. Individuals cannot invest directly in an index.
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly in this newsletter (article), will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for your portfolio. Due to various factors, including changing market conditions, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter (article) serves as the receipt of, or as a substitute for, personalized investment advice from Kaizen Financial Advisors, LLC. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. A copy of our current written disclosure statement discussing our advisory services and fees is available for review upon request.
1 - ici.org/pdf/2018_factbook.pdf