June 13, 2023
A Comparison Between Exchange-Traded Funds (ETFs) and Mutual Funds
Exchange-traded funds (ETFs) and mutual funds are two of the most popular investment strategies being utilized today. In this episode of Buckingham Weekly Perspectives, Head of Investment Research Jared Kizer shares five important distinctions between these growing investment vehicles.
Jared Kizer: So today I wanted to jump on and talk about exchange-traded funds contrasted with mutual funds. We got five points that we're going to get to go through to help you understand what the differences in those two types of investment vehicles are. This is important to understand because these are the predominant two ways that most folks are investing at this point. And also, we're seeing exchange-traded funds become a larger and larger portion of the marketplace over time. Just tremendous growth in the amount of investments that are flowing into the exchange-traded fund structure compared to the mutual fund structure.
Point #1: Timing Differences
Jared Kizer: So first point I would note is that when you think about exchange-traded funds, they trade continuously throughout the day, unlike mutual funds. So, if you're buying or selling a mutual fund, you basically got one time per day that you can do that. It's going to be at the end of the trading day. That contrasts to exchange-traded funds where you're essentially going to be able to buy and sell those throughout the course of the day that markets are open. So that's probably the single biggest trading difference to know about exchange-traded funds compared to mutual funds.
Point #2: Trading Differences
Jared Kizer: The second point I'd make, which is also a trading-related difference or a way to think about exchange-traded funds compared to mutual funds is that you can think about exchange-traded funds as trading like individual stocks. So, most people are pretty familiar with how individual stocks trade, the fact that they can be traded throughout the day. Also, the fact that the price that you get for your trade is going to depend typically upon whether you're buying or selling the stock, meaning those two prices will be slightly different in most cases. ETFs are similar in nature there, whereas with mutual funds, not only are you going to be able to trade those once per day, but it's going to be at a single price regardless of whether you're buying or selling. So notable difference, number two, they are related to the trading side of things.
Point #3: Taxation Differences
Jared Kizer: Now, I'd say the most tangible, meaningful difference would be point number three here, which is one of the reasons why we've seen such tremendous growth in the amount of assets invested in ETFs over time is that when you look at ETFs that are invested in individual stocks, those ETFs do tend to be more tax efficient for investors that are investing in accounts like individual accounts, trust accounts or maybe joint-related accounts. We don't have time today to go into the weeds in terms of why that's the case, but it definitely is the case that you tend to see ETFs that are invested in stocks be more tax efficient. And what I mean there is that in a typical year with mutual funds, you'll see some portion of the gains that they've generated throughout the course of the year from managing the portfolio have to be distributed at year end. So, you'd probably receive what are known as capital gains distributions in the past from owning stock mutual funds. By and large, a lot of ETFs basically don't distribute gains on a year-to-year basis, so they're able to defer those gains longer over time and reduce the year-to-year tax bill as a general statement there. So, in general, you do tend to see ETFs are more tax efficient.
Point #4: Taxation Similarities
Jared Kizer: On the fixed income side, exchange-traded funds that are investing in fixed income or bonds contrasted to mutual funds, there really aren't notable contrasts, at least not nearly to the significance of the tax efficiency difference that we pointed out on the stock side.
Point #5: Passive vs. Active Management
Jared Kizer: Last point, point number five would be with exchange-traded funds, most ETFs are investing in what are known as index or index-like investment strategies. So those are strategies that we would think of as passive investment strategies and generally a good approach to investing. Whereas with mutual funds you'll see a lot of index or index-like mutual funds, but you also tend to see a lot of mutual funds that are traditionally actively managed at this point. So that would be difference number five. Hopefully that's a helpful quick review of five points comparing ETFs to mutual funds. If you have additional questions that you'd like for us to tackle, feel free to reach out to your advisor or click the link below and submit questions in that way. Thanks.
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