Mutual Funds vs. Exchange-Traded Funds
A quick comparison of similarities and differences between the two
It's important for investors to understand the key differences between traditional mutual funds (open-end) and exchange-traded funds (ETFs). Each has its advantages and disadvantages. This knowledge can translate into making intelligent investment decisions. Let's focus on the key points.
Fees
The expense ratios of ETFs are generally lower versus active mutual funds. In some cases, this includes even index mutual funds. Also, ETFs often have lower trading costs versus actively managed funds, due to their low portfolio turnover. The ETF cost savings can be significant, especially for long-term investors. Investing in ETFs will usually result in a brokerage commission, but the savings from lower expense ratios can help to offset these transaction costs. Information on specific fees, charges, and expenses is obtained in the fund prospectus.
Fund Transparency and NAV
Actively managed mutual funds report their holdings on a quarterly or semiannual basis, whereas exchange-traded funds disclose their portfolio holdings on a daily basis. This provides ETF investors with a greater degree of financial transparency. The ETF performance and portfolio composition are a reflection of the underlying index. Consulting the index provider's Website is another method for easily identifying the underlying holdings of an index ETF.
Mutual funds are bought and sold at net asset value (NAV), which is determined by subtracting a fund's liabilities divided by the number of shares outstanding from the value of a fund's total assets. All buy and sell transactions are conducted directly with the fund company. In contrast, ETFs are bought and sold on an exchange based upon market prices, which fluctuate according to supply and demand.
ETFs generally trade close to their net asset value. It's rare to see ETFs trading at a large premium or discount to their NAV, but it can happen. Historically, institutions have seen this as an arbitrage opportunity by creating or liquidating creation units. This process keeps ETF share prices closely hinged to the NAV of the underlying index or basket of securities.
Taxes and Portfolio Turnover
Annually, both mutual funds and ETFs are required to distribute dividends and portfolio gains to shareholders. This is usually done at the end of each year and these distributions can be caused by index rebalancing, diversification rules, or other factors. Also, anytime you sell your fund this could generate tax consequences.
(1) For employer sponsored retirement plans ETFs may not be available as an investment option. Self-directed retirement plans may offer ETFs and a broader menu of investment choices.
(2) Most mutual funds impose a minimum investment or required dollar commitment, while others wave this requirement.
(3) Exception is Merrill Lynch's HOLDRs, which can only be bought and sold in 100-share increments.
| Mutual Funds vs. ETFs | Mutual Funds | Exchange Traded Funds |
| Continuous trading and pricing throughout the day? | No | Yes |
| Can be bought on margin? | Yes | Yes |
| Can buy/sell options? | No | Yes |
| Sold by prospectus? | Yes | Yes |
| Can use in an IRA, 401(k), or another retirement plan? | Yes | Yes(1) |
| Can be purchased through a traditional or online broker? | Yes | Yes |
| Minimum investment or share amount required? | Yes(2) | Yes(3) |
| Redemption Charges for Early Withdrawals | Yes | No |
| Traded on what exchanges | NA | Amex, NASDAQ, NYSE |
Brokerage Products and Services offered by Scottrade, Inc. - Member FINRA and SIPC
Any specific securities, or types of securities, used as examples are for demonstration purposes only. No information on this Web site should be considered a recommendation or solicitation to invest in, or liquidate, a particular security or type of security.
Investors should consider the investment objectives, risks, charges, and expenses of an ETF carefully before investing. For a prospectus containing this, and other important information, contact the fund company. The prospectus should be read carefully before investing.
Investors should consider the investment objectives, risks, and charges and expenses of a mutual fund carefully before investing. A mutual fund's prospectus contains this and other information about the mutual fund. Prospectuses are available through our trading site or through a Scottrade branch office. The prospectus should be read carefully before investing. No transaction fee (NTF) funds are subject to the terms and conditions of the NTF funds program. Scottrade is compensated by the funds participating in the NTF program through recordkeeping, shareholder, or SEC 12b-1 fees.
Investors should consider the investment objectives, risks, charges, and expenses of an Exchange-Traded Fund (ETF) carefully before investing. A prospectus contains this and other information about the ETF can be obtained from the issuer. The prospectus should be read carefully before investing.
Margin trading involves interest charges and risks, including the potential to lose more than deposited, or the need to deposit additional collateral in a falling market. Margin Disclosure Statement (PDF) is available for download, or it is available at one of our branch offices. It contains information on our lending policies, interest charges, and the risks associated with margin accounts.
Options are not appropriate for all investors. Detailed information on our policies and the risks associated with options can be found in Scottrade's Options Application and Agreement, Brokerage Account Agreement, and Characteristics and Risks of Standardized Options (also available at one of our branch offices). All option accounts require prior approval by Scottrade.
Online market and limit equity orders are just $7 for stocks over $1.
Market volatility, volume, and system availability may impact account access and trade execution.
Testimonials may not be representative of the experience of other clients and are no guarantee of future performance or success.