You may fully understand what a mutual fund is, and what an ETF is, but do you know which is better for your portfolio? They are both very similar products, but differ in specific ways you should be aware of.
What is a Mutual Fund?
A mutual fund is a fund that invests in a basket of stocks or other investments. They start with your cash, and managers use that cash to buy stocks. They can be actively managed, or they can mirror an index (in which case the stocks in the fund are the stocks in the index). Index mutual funds usually have fewer expenses, because you are generally not paying someone to make decisions.
When you own a mutual fund, you buy the NAV (net asset value), which is calculated at the end of the day. So, you can only buy at one price once per day. Mutual funds also have minimum investments, and sometimes fees to buy the funds.
What is an ETF?
An ETF is also a basket of stocks or other investments, but they usually only focus on an index. There are several actively managed ETFs, but these are pretty rare. Unlike mutual funds, ETFs prices are calculated every second, and investors can buy or sell just as often.
ETFs are made up of share baskets called creation units, which the ETF shareholders actually own shares of. As a result, these baskets are what provide liquidity on the market every day, and as such, trade like stocks.
ETFs also don’t have minimum investment limits, which are usually in place on mutual funds.
Which Should You Choose?
For many investors, picking an ETF usually makes the most sense. You usually want to have index funds anyway, and ETFs allow you to do this inexpensively.
ETFs also offer the advantage of trading as needed, so if you want to sell during market hours, you can, and your transaction will settle.
The main reason to choose a mutual fund is if you want a manager that is doing something outside of tracking an index. Then it could make sense for you.