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ETFs vs. Mutual Funds: The Pros and Cons of Both

ETFs vs. Mutual Funds: The Pros and Cons of Both

| September 19, 2023

Exchange-traded funds (ETFs) and mutual funds share many similarities. Both take a pooling of investor funds that are applied to several different commodities. They can both instantly diversify one’s portfolio, which is a key to controlling risk. Additionally, both are managed by financial professionals to maximize shareholders’ value.

However, there are a few differences between mutual funds and ETFs that investors need to consider. While both can add value to your holdings, one may be more suited to your investment goals and trading strategy. We’ll examine some of the primary differences between the two instruments.

Investor Accessibility

The most striking difference between mutual funds and ETFs is when and where you can trade for them. While ETFs can be traded at any time on the stock exchange, it takes a little more legwork to invest in mutual funds.

Mutual funds are priced after the stock exchange closes for the business day. Transactions are recorded after hours. This is meant to give the fund more stability and predictability, shielding it from marketplace volatility and trader impulsiveness. 

Therefore, they’re more attractive to investors who prefer to buy and hold for the long term.

ETFs, on the other hand, can be traded on the exchange at any time of the business day. Their prices fluctuate the same way as other commodities. Since they’re more responsive to immediate price movements, ETFs may be more enticing to active traders who make more aggressive, frequent transactions.

Liquidity

The difference in accessibility between mutual funds and ETFs relates to their liquidity — how easily they can be converted into cash. Since they’re priced and traded after the stock markets close, mutual funds are harder to sell and, therefore, less liquid. 

Again, this may be preferred by investors who take a more passive, hands-off approach to their portfolios. 

ETFs are traded exactly the same way as traditional stocks. They’re more instantly convertible to cash, so they’re more liquid than mutual funds. That aspect attracts active traders who want to generate profits more strategically and frequently. It also makes them slightly riskier than mutual funds.

Management and Structure

Mutual funds and ETFs are both managed by financial professionals. While both kinds of managers are charged with overseeing and adjusting their holdings, how they do so can vary.

Mutual fund managers are generally active. In fact, just managing one mutual fund is a full-time job (or several full-time jobs). From deciding what commodities to fund to keeping close track of the marketplace, managers are responsible for every component of mutual funds.

That description also fits many ETF managers. However, by their flexible nature, ETFs do open up to more fluid or passive management styles. One could start an ETF that just mirrors the listings of a stock index like the S&P 500. Since those indexes don’t change that often, their corresponding ETFs can be more passively managed.

Fees and Expenses

Perhaps the second-most notable difference between ETFs and mutual funds is how much they cost. These fees are also informed by the structures and management styles of both.

Mutual funds generally carry higher expense ratios than ETFs. There’s more work to be done in management, administration, marketing, and research with a mutual fund. 

Many mutual funds also charge “load fees” as a kind of commission. These fees can be charged when shares are first purchased  (“front-end”) or when they’re sold or redeemed (“back-end”).

ETFs, on the other hand, don’t always require the same high level of management, so their expense ratios are inherently lower. There are also no load fees with ETFs, although there may be some brokerage commission charges.

Tax Implications

Mutual funds tend to carry more tax liability than ETFs. When a fund manager decides to exit a position on the fund, it creates capital gains that incur additional taxes. If an unusually active manager buys and sells frequently, those taxes can pile up — and are passed down to shareholders. 

Furthermore, if an investor buys into a mutual fund immediately before the managers hand out profits, they may be liable for taxes on income they didn’t realize.

ETFs are generally shielded from these high tax factors. There may still be capital gains taxes, especially if an investor buys and sells their shares within the same year. But the investor is in charge of transactions rather than a manager, so they control much of their own fate when it comes to taxes.

Learn More With Good Life

Are you interested in finding out more about mutual funds, ETFs, or other financial instruments that can build up your portfolio? Contact Good Life to set up a risk-free consultation. We’ll go over your current financial status, investment goals, and possible solutions for growing your wealth.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. 

Investing in mutual funds involves risk, including possible loss of principal. Fund value will fluctuate with market conditions and it may not achieve its investment objective. 

ETFs trade like stocks, are subject to investment risk, fluctuate in market value, and may trade at prices above or below the ETF's net asset value (NAV). Upon redemption, the value of fund shares may be worth more or less than their original cost. ETFs carry additional risks such as not being diversified, possible trading halts, and index tracking errors.