ETF’s vs Mutual Funds
Introduction:
The ETF market is one of the fastest-growing investing approaches since its introduction in 1993. Since the COVID-19 pandemic, the use of ETFs substantially grew, as the market reached a height of 3.9 trillion dollars in traded material. As the ETF market grows, so does the mutual fund market, expected to grow by 6.5% by 2023. While its asset market size stands at 56.2 trillion dollars, it continues to become a popular strategy used by investors. As both strategies continue to popularize, both in use by banks and by private traders, the argument between the use of these strategies continues to grow synonymously.
What are ETFs?
ETFs are exchange-traded funds that involve the trade of an index and are purchased/sold on the stock market. An ETF can involve multiple securities and is traded similarly to a share on the stock market. For example, a popular ETF is the SPDR S&P 500 which tracks all of the 500 top businesses in the United States. Additionally, the price of ETF shares fluctuates over the course of the day based on a series of factors such as the popularity in the market and in the performance of the companies within the security.
Why invest in ETFs?
Portfolio Diversification:
As ETFs involve the use of large securities, there is room for portfolio diversification as traders invest in multiple companies or an industry. As a result, ETFs can result in less market volatility as it takes multiple companies to crash for the market to be volatile. There is more leeway for investors to sell their ETFs in case of a crash as the effects will be minimal. For example, take into account the SPDR S&P 500(tracks all 500 top U.S. companies). If 1 of the companies listed on the SPDR S&P 500 crashes, it would have minimal effects as over 500 companies’ shares accumulate to its overall price. It would take multiple crashes to cause financial concern to an investor. However, it is important to note that the same can be said for improvement in the stock. It takes multiple companies to grow and prosper for an ETF to increase in price.
Tax Benefits:
ETFs have recently become popularized by investors because of their ability to avoid capital gains tax. ETFs designate large financial institutions such as banks the ability to “redeem” ETF shares. In doing so, the ETFs can avoid selling their assets/shares and avoid the use of capital gains tax. Therefore, banking companies are keen to invest long-term so that they may maximize the potential yield that the ETF brings in without any capital tax gains. Additionally, ETFs are labeled as “pass-through” which means that investors only pay taxes on the money they make from ETFs. Rather than paying higher taxes on the full price of the ETF, investors are only required to pay taxes on the amount of profit they get.
What are Mutual Funds?
Mutual funds involve a large portfolio of stocks that are generally managed by market professionals such as money managers. This ensures that every shareholder, including the company managing the portfolio, loses/gains at the same time. This motivates the company owning the mutual fund to have their investor’s best interests and make as much money as possible. Similar to ETFs, mutual funds consist of a large security and diverse portfolios. However, mutual funds may only trade once per day at 4 PM ET as that is when the price of the fund is calculated, given the rise/losses seen in companies throughout the course of the day.
Why invest in Mutual Funds?
Professionally backed investment:
As mentioned above, mutual funds are managed by large financial companies such as Fidelity and fund managers. This ensures that one’s investment will be better performing as the financial entity controlling the fund has the equivalent level of risk. This can be beneficial to beginner investors, looking to learn more about investing while ensuring convenience. Mutual funds distribute dividends without the work of the investor, saving time and ensuring that a beginner investor can learn more about the market.
Historical Performance:
Mutual funds are notorious for their high level of return on investment yield, averaging an annualized return of 11.5%. Mutual funds are capable of large growth in short periods of time during a strong economy. When the economy is in a positive trend, many businesses are as well, increasing the prices of their shares and allowing mutual fund investors to accumulate more wealth. Mutual funds are generally seen as a strong long-term investment strategy as there is more room for companies within the security to grow and prosper. The use of professionals in choosing their set list of companies also allows for a greater peace of mind for investors.
Conclusion:
As both ETFs and mutual funds become popular as investment strategies, it is important to note that both strategies include pros and cons. Both strategies are effective investments and differ in one’s interests and level of risk tolerance. Note that both of these strategies can result in losses and that this article is solely for the purpose of informing readers and future investors.
