Mutual funds were very popular in the 1980-90s, with Fidelity Magellan and Vanguard Index 500 gathering the most assets.
Exchange-traded funds (ETFs) emerged in the 2000s and are growing faster than mutual funds. That’s why mutual fund giants Fidelity and Vanguard have introduced their own ETFs. Here are the similarities and differences between mutual funds and ETFs.
Both mutual funds and ETFs hold a basket of securities (usually stocks or bonds). For example, when an investor owns an S&P 500 index fund he literally owns all the 500 stocks in the index. Both security types offer diversification.
Mutual funds and ETFs trade differently. Mutual fund trades are executed at the end of the trading day. For traders that is unacceptable.
For long-term investors, however, it’s of no consequence.
ETFs trade on stock exchanges throughout the day. A commission (usually about $8 at a discount brokerage firm) is charged when an ETF is bought or sold.
Both mutual funds and ETFs charge management fees. ETF fees tend to be lower than mutual funds, but that’s because most mutual funds are actively managed while most ETFs are not.
Even when you compare apples to apples, however, ETFs have slightly lower fees. For example, the Vanguard Index 500 mutual fund charges 0.17 percent of assets while the Vanguard Index 500 ETF’s fee is an amazingly low 0.05 percent.
ETFs are more tax efficient than mutual funds. That’s because mutual funds distribute capital gains payments to shareholders at the end of every year.
That means you’ll pay capital gains tax even if you didn’t sell your shares. Equity ETFs, however, are taxed like a stock. Your cost basis is how much you paid and you don’t pay capital gains until the security is sold.
I was a mutual fund investor in the 1980s and I still consider funds to be very good investment vehicles. That said, I prefer ETFs.
For taxable accounts, they grow tax deferred until they are sold, their management fees are low, and I like having the ability to monitor their performance throughout the day.
David Vomund is an Incline Village-based fee-only money manager. Information is found at www.ETFportfolios.net or by calling 775-832-8555. Clients hold the positions mentioned in this article. Past performance does not guarantee future results. Consult your financial adviser before purchasing any security.