With the rising popularity of exchange-traded-funds (ETFs), many investors are confronted with the decision of choosing an ETF or a mutual fund. Both types of investments serve a similar goal — holding a pool of investments — but there are notable differences that set them apart.
The way that shares of mutual funds and ETFs are traded plays a role in the pricing that investors get when they place an order. With mutual funds, you trade shares only at the net asset value (NAV), which is determined at the end of the trading day. ETFs can be traded — like stocks — at any time during the trading day.
Both ETFs and mutual funds come with annual expenses to pay fund managers and administrative costs. But, the expense ratios for ETFs tend to be less than that of mutual funds because the internal processes of managing an ETF requires less work than that of mutual funds.
The costs of buying and selling shares of ETFs and mutual funds differ because ETFs trade like stocks. Most brokerages charge higher commission fees for trading shares of mutual funds.
Also, mutual funds may have minimum investment amounts that would require investors to put in a certain amount of money to invest. ETFs don’t have this requirement.
Finally, automatic dividend reinvestment options are available with mutual funds, while ETFs don’t have any way of reinvesting dividends (other than initiating a new buy order). Mutual-fund investors can use dividend reinvestment to stockpile a particular investment without having to remember to do so.
If you are stuck between a mutual fund and ETF that have similar holdings, consider the advantages and disadvantages of each type of investment.