Both mutual funds and ETFs have become very popular because of their low-risk and simplicity, but which one is a better investment. Comparing the benefits of ETFs and mutual funds involves some complexity, but here are a few basic facts to get you started:
Differences Between ETFs and Mutual Funds
ETFs and mutual funds are similar in this way: They both put together a basket of stocks and then let you buy shares in the whole basket rather than in each individual stock. The main difference between ETFs and mutual funds is in how they are traded. The "T" in ETF means that it is traded on the open market. If you decide to sell your ETF shares, you are interacting with the live stock market and you can get the price that your ETF shares are selling for at any given moment. With a mutual fund, you sell your shares back to the mutual fund company, and you will get the closing price at the end of that day. These two different purchasing structures involve different kinds of costs for you. ETFs usually charge you a commission for each transaction, whereas mutual funds charge brokerage fees. Most online investing sites do offer both mutual funds and ETFs, but it is always smart to check beforehand just in case. Here's a list of some good online investing sites that offer both ETFs and mutual funds.
How Much Do You Want to Invest?
ETFs are growing in popularity because they are more open to small-scale investors. Just as you can buy one share of stock, you can also buy one share of an ETF. (Very small investments like this may mean that you pay a higher percentage of your money in trading commissions, however. Small investors should shop for ETFs with the lowest fee structure.) Mutual funds, by contrast, often require a minimum investment of $10,000 or more.
Are Taxes an Issue for You?
You may have to pay capital gains tax every year on the profits of your mutual funds, even if you haven't sold your shares. However, this tax issue may not apply to you if your mutual funds are part of your retirement account. On the other hand, owning ETFs is like owning stocks: You only pay capital gains tax on your profit when you sell your shares.
Are You Investing All at Once or Bit by Bit?
If you have a single lump sum that you want to invest, perhaps as a result of rolling over the contents of your 401(k), CNN Money advises that you'll do better with an ETF. However, if you want to invest a regular monthly amount or just add to your portfolio whenever you have spare cash, you'll pay less by choosing a mutual fund. This is because ETFs have trading commissions, just like any stock.
It's important to do some research before you invest in an ETF or mutual fund, because they are offered in many different forms and price structures. Keep in mind that if you want to do your investing online, you need to check with the website first to make sure it includes either ETFs or mutual funds, like these do.