ETFs vs Mutual Funds and The Fundamental Difference

ETFs are very much like mutual funds. That is, they are baskets of stock that are bought and sold. But they have many differences  from mutual funds.

The fundamental difference between ETFs and mutual funds in that shares of ETFs can be traded at any time while the host stock market is open. Mutual funds, which do not trade midday, take orders during trading hours, but the transactions actually occur at the close of the market. Not so for ETFs, which trade instantaneously all day long and allow an investor to lock in a price for the underlying stocks immediately. Although they are constructed like mutual funds, ETFs trade like individual securities on stock exchanges. This gives investors the best of both worlds, as they combine the conservative diversity of a mutual fund with the flexibility of a stock.

ETFs are more tax-efficient than normal mutual funds. The method in which ETFs are created and distributed means that investors do not pay out capital-gains taxes until actually they sell their ETF. Mutual funds, however, are a different story: Capital gains must be distributed to shareholders. The delay in paying taxes derived from owning ETFs rather than mutual funds can be beneficial for a stock portfolio.

ETFs are not actively managed and are therefore less expensive to own than mutual funds. They have very low operating and transaction costs associated with them. Their annual fees are as low as 0.09% of assets, which is breathtakingly low compared to the average mutual fund fees of 1.4%. In addition, there are no sales loads or investment minimums required to purchase an ETF.

Because their financial flexibility, tax-efficiency, and low expenses, ETFs attract more investors than mutual funds and have grown significantly in popularity over the last few years.