A mutual fund pools money received from investors, and issues fund shares to shareholders. It then invests in securities (stocks, bonds and money market instruments) related to the fund's investment objective. The fund provides shareholders with professional investment management, diversification, liquidity and investing convenience. For these services, the fund charges fees and incurs internal expenses for operating the fund, all of which are charged proportionately against a shareholder's assets in the fund. There also may be front- end (purchase) or back-end (sale) charges (loads), which are sales commissions charged upon buying or selling the mutual fund. However, there are no-load mutual funds available that do not charge sales or redemption fees.
Purchases and sales take place between investors and the mutual fund. Mutual funds issue and redeem shares of the fund at their net asset value (NAV), which is the price at which you can buy or sell a share that is calculated after the market closes for the day.
ETFs are most comparable to open-end mutual funds. Open-end mutual funds are pooled investment vehicles and issue or redeem (repurchase) shares on demand.
ETF stands for exchange-traded fund and is generally a passively managed pooled investment vehicle designed to match the performance of a benchmark, such as an investment index, industry sector, or asset class. Investors who own shares of an ETF do not directly own the underlying asset. An ETF is created or redeemed in large lots by institutional investors who trade the shares throughout the day between investors just like shares of common stock. Unless they are a proprietary fund where the fee is waived, ETFs incur a brokerage commission. ETFs do not charge upfront load or other purchase fees that would increase their cost. Because they do not require significant overhead or resources to administer, management costs are comparatively low.
Some popular examples of ETFs are the SPDR S&P 500 (SPY), which attempts to replicate the investment performance of the US equity market by tracking the S&P 500 Index and the Vanguard REIT ETF, which attempts to replicate the investment performance of US real estate investment trusts by tracking the MSCI US REIT Index.
Mutual funds can lack transparency about what they are investing in as holdings may change (turnover). It is not uncommon for an investor in different mutual funds to be invested in the same stocks, causing overexposure to specific companies or industry sectors. Because of the simplicity of ETFs and because most are linked to specific indexes, investors are potentially less likely to be overexposed to specific securities with an ETF.
Information provided by Treybourne Wealth Planners should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security.
All investing involves risk, including the potential for loss of principal. There is no guarantee that any investment plan or strategy will be successful.