Index mutual funds differ from exchange traded funds in various ways. Investors need to be aware of the differences in these funds and know which type suits their investing style.
“The investor should understand market dynamics as they affect asset class behavior and be able to understand and justify their decision-making process, not forgetting that trading costs can reduce investment returns,” Mark L. Ross for Investopedia wrote. [What’s Driving the ETF Boom?]
Overall, ETFs are a more sophisticated investing tool that allows investors to trade daily, with the ease of a single stock or buy-and-hold for varied time increments. Institutional investors like ETFs for their tradability and because they can be bought on margin or sold short. [An All-Seasons Model ETF Portfolio]
ETFs also allow investor access to hard to reach areas of the market such as currencies, physical commodities and niche markets. Other investing duties that ETFs can accomplish are tactically allocate asset classes, take directional bets and hedge other investments.
Mutual funds are great for a buy-and hold strategy but are not as nimble as ETFs. Since mutual funds can only be bought and sold at the end of the day, they are not used for trading. [ETFs VS. Index Funds]
Plus, large redemptions on mutual funds can cause capital gains distributions for non-redeeming shareholders. This is a major flaw of mutual funds. There are no margin trades allowed, no limit orders or short selling permitted with mutual funds
On top of all of this, the costs associated with investing in mutual funds are much higher due to sales loads, and active management.
Investors should have a good picture and outline of their investment goals and what they expect their investment outcome to be. It is apparent that ETFs and mutual funds differ greatly, so it is up to the investor to decide which tool is going to fit into their investment profile.
Tisha Guerrero contributed to this article.