When faced with different investment options, some investors can get confused and frustrated. Mutual funds and exchange traded funds both appear attractive due to their diversification, low costs, and regulated nature. However, a deeper investigation reveals that mutual funds are actually a safer and overall better investment option than ETFs.
Both of these investments hold a basket of bonds or stocks. The difference is in how investors purchase and sell shares. ETF investors have to trade with other investors within the market, whereas mutual fund investors can purchase and sell their shares with a fund company. Therefore, the average investor has to use a broker to purchase or sell ETF shares, which can increase costs.
Mutual fund prices are established once daily, while ETF prices fluctuate throughout the day. This requires ETF investors to spend more time tracking the price to ensure a good deal. ETF funds can be narrowly focused in terms of their investments, which can be a double-edged sword. Investors tend to sell these at the wrong times, losing money.
In terms of dividends, most people who invest in mutual funds use the automatic dividend reinvestment. When dividends are paid by the fund, the investor’s portion is automatically reinvested to purchase shares, or fractions of shares, within the fund. ETFs deposit the dividend payments into the brokerage account. To reinvest these, the individual must make another purchase and could be slapped with a regular trading fee.
There are claims that ETFs offer great tax advantages but a lot of these are exaggerated. Individuals need to pay tax on capital gains and dividends. Even within the mutual fund and ETF industries, there is disagreement on the tax advantages of the ETF. To keep costs low and minimize risk and volatility, opt for a mutual fund rather than an ETF.