Exchange traded funds and mutual funds have differences when it comes to the costs associated with overseeing the fund and tax efficiency. The reason there are cost differences is due to the differences in structure of these tools and the way they are managed.
The management fees are the main cost difference between an ETF and a mutual fund. Since a mutual fund is actively managed, by an actual fund manager, the fees incurred are higher. Management fees are lower for passive, index-linked ETFs because the fund is not responsible for the related accounting, the brokerage firm takes care of this, and because the fund tracks an index of stocks passively. There are some ETFs that are actively managed, however. [What You Should Know About ETF Bid/Ask Spreads]
Mutual funds also have a daily rebalancing that takes place at the end of the day, due to daily net redemptions. This results in commission costs and expenses in the bid-ask spread on subsequent underlying fund trades. Shareholders of a mutual fund are all responsible for transaction costs incurred by other shareholders owning the same fund regardless if they make a trade or not. [Three Things to Remember About ETF Premiums and Discounts]
ETFs have an “in-kind” creation and redemption process. Shares of ETFs can be created and redeemed within a basket of stocks and incur no transaction costs, reports Investopedia.
ETFs do provide investors with a low-cost tool for the buy-and-hold investor. However, for those investors that like to trade daily, beware–brokerage fees can add up quick. Overall, ETFs can not be beat by mutual funds in terms of low cost and passive indexing. [How ETFs Save on Fees and Taxes]
Tisha Guerrero contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.