What is a Better Investment, ETFs or Mutual Funds?

At first glance, both mutual funds and Exchange Traded Funds (ETFs) look like good investments. Both investments diversify your portfolio, and have low costs. That being said, when you dig a little deeper, these funds provide even more benefits.

Let’s begin by taking a more in depth look at Exchange Traded Funds (ETFs).

ETFs are sometimes considered the polar opposite of mutual funds. These funds work by tracking a particular index, and are focused on stocks rather than cash. So, what is the difference between cash and shares? Mutual fund companies have control over billions of shares of investments. In order to establish an ETF, fund companies take a few million of these shares, and group them together so they are representative of a particular index, for example the Nasdaq. The fund then deposits these shares to be held with a holder, and a number of creation units are received back. Basically, stocks are being traded for creation units, which is a form of buying into a fund using equity instead of cash.

Creation units are large blocks of shares of an ETF, generally fifty thousand or more. These units are then broken up by recipients into individual shares which are then traded on the open market. When more creation units are needed, they can be made when institutional investors deposit extra shares into the fund. That being said, ETF shares can cease to exist if a large investor decides to exchange creation units back for basic shares.

Now let’s take a look at mutual funds.

Mutual funds are usually managed by a management team and are cash based. Investors send their money to the fund in exchange for receiving shares of the fund. The managers are then in charge of using this cash to determine what to buy to increase the value of the fund, as well as individual returns.

The idea of a mutual fund is that individual investors gain a diversified portfolio, without having to manage their money personally, and without having to worry about which stocks and bonds should be purchased. Mutual funds can come with many different fees and restrictions so it is very important to research all of the costs entirely. In some cases, returns may be subject to high tax rates, which is another issue that should be investigated prior to investing.

Essentially, it comes down to the individual investor and individual investment goals when determining if an ETF or a mutual fund is best. Each have very unique benefits, and each come with varying levels of risk. If you are completely new to the world of investing, you may wish to consult with a professional investment planner for help with this matter, or for more in depth information.

Tags: cash, diversified, ETF, stocks