Depending on how loosely you define them, you could say that mutual funds—investment strategies wherein many investors pool their money together—have been around since at least 1868, when shares of the Foreign and Colonial Government Trust were first issued by the British Government; they still trade on the London Stock Exchange today.
Given their lengthy head start over exchange-traded funds (ETFs)—a different type of investment fund—it’s no surprise that mutual funds still rule the roost when it comes to sheer size, boasting some $17 trillion in assets under management as of August 2017. ETFs only first appeared on the scene in the U.S. in 1993, but they have been rapidly gaining ground in market share, popularity, and assets under management as interest in mutual funds has slowed. In just 25 years, ETFs worldwide have already gathered some $4.9 trillion in assets under management (as of July 2018). In 2017, they registered inflows of $464 billion, shattering 2016’s record of $288 billion.
So what is so special about ETFs, and how are they different from mutual funds?
In many ways, ETFs and mutual funds are not so different from one another. Both investment vehicles typically offer exposure to a basket of securities, and both can be used to gain access to various strategies, asset classes, and sectors of the market. Many of the similarities end there, however.
Buying and Selling
Mutual funds can only be purchased directly from a mutual fund issuer or through a financial intermediary, and may only be bought or sold once per day after markets close. On the other hand, ETFs can be bought or sold throughout the day like stocks—it’s where the “exchange-traded” part of their name comes from.
There can be a lot of complex fees associated with buying, selling, and owning mutual funds, which may include one-time fees known as front-end loads—sales charges when an investor first buys into a fund—as well as back-end loads, which are charged when an investor wishes to exit a fund. As part of their management fees, mutual funds often also include what are known as 12b-1 fees, which are used for sales and promotional activities. Mutual fund management fees for equities typically average about 0.63%, but can often range above 1%. In addition, many mutual funds often require a minimum investment size, ranging from $500 to $3,000 or more.
On the other hand, the fees associated with ETFs are fairly straightforward. There are no minimum investment amounts beyond the share price of the ETF, no front- or band-end loads, and no 12b-1 fees. ETF investors can expect to pay a commission when they buy or sell ETF shares, much as they would when trading stocks. Management fees for ETFs tend to be a bit lower than those of mutual funds, averaging 0.44%, although many equity ETFs can be as low as 0.10% or less.
Mutual funds disclose their holdings on a quarterly or even semi-annual basis, while ETFs disclose their holdings daily. This feature can be advantageous for ETF investors as they seek to make strategic allocations within their portfolios using more up to date information.
Thanks to their underlying structure, which typically avoids passing along most capital gains to shareholders, ETFs tend to be much more tax efficient vehicles than mutual funds.
There is a lot to consider as you weigh whether ETFs or mutual funds are right for you. Be sure to consult with an investment professional as you take stock of your options.
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