What Are The Differences Between Mutual Funds and ETFs?

August 11, 2022 3 min read

What Are The Differences Between Mutual Funds and ETFs?

What Are The Differences Between Mutual Funds and ETFs?

In the investment world, there are lots of unending debates. Every side always has a point on how it is better than the other side. While the results have been inconclusive on many occasions, some have been able to express why one side is slightly superior to the other. One of such debates is Mutual Funds vs. ETF. 

Mutual Funds and Exchange-Traded Funds share several things – for instance, they deal with a variety of assets that investors are interested in. They are professionally managed collections of securities like stocks and bonds. 

However, while you may see them have certain similarities, they also have their differences. A significant distinguishing factor between both funds is the purchasing time/trading point. Mutual Funds are only bought at the end of a trading day, while ETFs are traded in-between days like stocks. 

As it is important to express other differences between the two index funds, defining each of them is paramount.

What is a Mutual Fund? 

A Mutual Fund is a high-value investment with low requirements depending on the type and the company providing it. This index fund is one of the oldest funds, as it was launched about a century ago. It is often managed by a professional, and such a person might have to work with a team to decide when to buy or sell stocks. However, the price of this fund isn’t determined immediately; instead, at the end of a business period or when net asset value (NAV) is established. 

So far, there are two types of mutual funds. 

Open-End Mutual Funds

These mutual funds are the most popular types in the stock market. The sales or purchase of this fund is often between an investor and the company providing the fund. It is also popular because of its no-limit policy, i.e., there are no restrictions on how much you can buy as long as you have the money. Open-End Mutual Funds make sure that individual share value is not influenced by the outstanding shares available. 

Closed-End Mutual Funds

These mutual funds are only for a specific audience. These funds are not readily available; hence, they are only issued to certain investors. The prices of these funds are not dependent on the NAV; instead, on the demands of investors. It is more of a “who can afford these shares at a price higher than usual.”

What Is an Exchange-Traded Fund?

Exchange-Traded Fund isn’t as old as the Mutual Fund. It was designed by institutional investors to trade shares during the day, just like stocks. Due to the consistent pricing of ETFs by the market, there is a chance to conduct as many trades as possible without using the NAV. 

It is different from many other investment vehicles because of the Creation/Redemption strategy. Creation involves buying all outstanding securities around the ETF and bundling them into a single structure, while Redemption involves unbundling them into independent securities. 

ETFs come in 3 types: 

Open-End Fund

Most ETFs are open-end funds because of their registration – the SEC Investment Company Act of 1940. This type of ETF comes with detailed requirements, such that nothing more than the portfolio’s 5% can be invested in an independent stock’s securities. This open-fund end also allows investors to reinvest dividends and also lend securities. 

Unit Investment Trust (UIT)

Also, according to the Investment Company Act of 1940, investors can go for the unit investment trust (UIT). It often involves replicating specific trades indexes in the exchange-traded fund to reduce tracking errors. People who hold UITs are prohibited from lending securities or holding derivatives. 

Grantor Trust

The last type of ETF is the Grantor Trust. It is often recommended for those who want to invest in commodities. Unlike the other ETFs, the Grantor Trust is not registered under the Investment Company Act of 1940; instead, it was registered under the 1933 Securities Act. However, it doesn’t permit the reinvesting of dividends but direct payments to significant shareholders.

The Future of ETFs and Mutual Funds

There is a likely chance that ETFs predominate the mutual fund space in the future. The reason is that many investors are suddenly becoming interested in ETFs because of their low fees and the tax advantages. 

As a matter of fact, at the end of 2021, ETFs had over $300B of investor money, while Mutual Funds had around $80B. 

In summary, Mutual Funds are different from ETFs in the following: 

  • More tax liabilities 
  • Trades at closing net asset value
  • Lower liquidity 
  • Zero transaction costs
  • Varying operating expenses