Mutual Fund vs. ETF the Main Difference

Mar 11, 2020 02:36 PM ET
  • The difference between ETFs & Mutual Funds and how to choose the right option.
Mutual Fund vs. ETF the Main Difference

Investing is always the main driving force of the economy. The market is developing, and we can observe various innovations. Today, investors can use hundreds of tools to make money work. Mutual Fund and ETF are the first options worth checking out. But what to choose for further profit? Is it safe, and what risks await the investor? Let’s get it right.

Mutual fund

Mutual Fund is a form of collective investment that allows investors to acquire a share of the fund, thereby gaining access to its portfolio of assets. The investment objectives of the fund determine the choice of assets. Information on the fund’s investment strategy, its risks, and returns, as well as on all fees levied, can be found on the fund’s website and in its prospectus.

Mutual fund

The profitability of a mutual fund is the sum of the indicators of its total return and transaction costs. In turn, the total income of the fund determined from the calculation of its dividend (interest) income and changes in the value of its net assets - NAV for the period. When the price of assets in the fund’s portfolio rises, so does its total return. The decrease in the value of net assets leads to a reduction in the yield of the fund.

An additional source of the fund’s profitability is the reinvestment of dividends received on shares in the asset portfolio. If the profits paid by the fund reinvested in the purchase of new securities, this contributes to the growth of its total yield.

Mutual Funds Risks

First of all, this is a professional investment portfolio management. Having paid a minimal fee to the manager, you will receive an experienced financial expert in the allies who will tell you how best to form a portfolio of investments based on your attitude to risk and profitability.

These are also lower risks. One of the distinct advantages of investing in mutual funds is that the chances of investment are reduced due to broad diversification - difficult for an individual investor to achieve. Most mutual funds invest in a wide range of types of securities - from 50 to 200, and large giants - up to 1000. It is unlikely that it will be possible to diversify a portfolio alone.

Mutual Funds Risks

Units of investment funds are highly liquid assets. If you want to sell your share, all you need is to give instructions to your broker, and funds will send to your bank account within 24 hours. For example, with real estate or land, the situation is different. It may take months before you can convert them into cash, which imposes certain restrictions on the investor.

There are a large number of mutual funds for management style and strategy, and investors can choose what they like. For example, there are mutual funds that invest exclusively in the high-tech sector. Others focus on Asian markets; others focus on gold, etc.

What is the ETF?

ETF is a unit investment fund with shares of which you can perform precisely the same operations on the stock exchange as with shares of any ordinary enterprise.

For example, ETF-fund shares have much higher liquidity. If mutual fund units can sell and buy only once a day since their value is updated only after the close of trading by dividing the benefit of all net assets of the fund, thus, the ETF-fund shares can be bought and sold at any time during the whole trading day. Their value, like the value of ordinary shares, is determined by the behavior of bidders.

ETF

Besides, if it is impossible to conduct margin trading with units of a regular mutual fund since it is forbidden to buy them on credit or borrowed funds, there are no such restrictions on ETF fund shares. It makes it possible to conduct a “short game” with shares of ETF funds, as well as use leverage to purchase them, which makes transactions with this type of securities potentially more profitable, but equally risky.

Also, when trading stocks of ETF funds, because it occurs directly on the exchange, additional commission fees are not levied, which may be provided for when buying/selling ordinary investment units, which traded through specially authorized persons.

ETF Risks

The main minus is the increased risk of investing in ETF stocks compared to financial instruments with fixed income and government guarantees for the return of funds (bank deposits, bonds and other types of debt obligations), and in the case of margin trading in shares - compared to ordinary mutual funds.

ETF Risks

The disadvantages are that the investor does not even partially become the owner of the company or its debt. Consequently, extraordinary events, for example, participation in a company in a significant transaction with which the ETF holder does not agree, can harm the value of his portfolio, as he will not be able to present securities for redemption.

It is worth paying attention to the fact that ETF funds do not pay dividends, which will lead to the absence of passive cash flow during the retention of these assets. Besides, the ETF structure is not always clear and transparent.

What to Choose?

The choice of a specific investment option depends on your capabilities and goals. Let’s look at the possibilities of ETF funds. First of all, you can enter the market with a small budget (low entry threshold). Another plus is the ability to cover many sectors of the economy and the market immediately. If there is no money for shares of individual companies, then you can invest in them through an ETF fund. Also, these are low commissions regarding a relatively independent set of positions.

The main advantage of mutual funds is their professional investment portfolio management. These are also lower risks. One of the distinct benefits of investing in mutual funds is that investment risks reduced through widespread diversification. Also, do not forget about liquidity. Units of investment funds are highly liquid assets. If you want to sell your share, all you need is to give instructions to your broker.

Investments carry the risk of losing part of the savings or even the entire amount. Accordingly, starting to invest, you will encounter typical investor companions - fears, doubts, hesitations, worries, worries, etc. To avoid this, and for the investment process to bring you satisfaction and positive emotions, you must determine your comfort zone - that is, the limit of risk that you are ready to accept without nervous tension and panic.

Remember: no investment is worth waking up at night in a cold sweat, turning on your computer, and checking the current value of shares or mutual funds.


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