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ETF vs. Mutual Fund: Which Is the Better Investment?
If you’re a novice investor, you may find yourself overwhelmed by the investment options that are available. In this post, we’ll explore the differences between an ETF and a mutual fund, helping you to decide which one might be the better investment.
What Is an ETF?
An exchange-traded fund (ETF) trades on exchanges like any other stock. These trades take place between individual investors, as opposed to using a fund manager. Because they can be bought and sold at any point during a trading session, an ETF has the potential to reflect the market more readily than a mutual fund can.
An ETF is passively managed, which means that it will seek to replicate the performance of a particular index (e.g., the S&P 500). This makes ETFs a bit cheaper than a mutual fund. Because there’s less internal trading, ETFs can also offer greater tax efficiency.
What Is a Mutual Fund?
In a mutual fund, an investor makes a transaction through a fund-managing company, such as Vanguard or BlackRock. The buying and selling process is straightforward, based on the net value of the assets at the current market price.
However, mutual funds often have penalties if you sell too early, usually within 90 days of making your initial investment.
Mutual funds are actively managed. This means that your fund manager will work to optimize your investments against an index such as the S&P 500. This can make them a bit more costly to run, though the benefit is that mutual funds are a bit less risky than an ETF.
Unlike ETFs, mutual funds only allow one transaction per day. This means that they tend to reflect the market less directly than an ETF, which allows transactions to take place multiple times per day.
Which Is the Better Investment?
Both ETFs and mutual funds can include portfolios of stocks, though they differ in some key ways. Which is the better investment? That depends on your strategy.
Reasons to Consider an ETF
You may want to consider an ETF if:
- You plan to trade actively or participate in day trading
- You want greater tax efficiency
- You want greater personal choice over your individual investments
Some novice investors aren’t interested in all of these features, but if you are, you won’t find these kinds of hands-on practices in a mutual fund.
Reasons to Consider a Mutual Fund
You might consider a mutual fund if:
- You’re looking for a longer-term investment
- You want a fund that can outperform industry benchmarks
- You want a fund manager to guide you in the process
Many first-time investors rely on mutual funds, as they can seem a bit simpler than ETFs. On the other hand, experienced investors may appreciate the lower costs and flexibility of an ETF.
The Best of Both Worlds
If you’re still undecided, why not try both? There’s no reason you can’t split your investments between a mutual fund and an ETF. Simply monitor your investments to determine which process yields a better result based on your investment goals.