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Difference Between Mutual Funds and Exchange Traded Funds

Since ETF’s can be bought and sold in real time prices that change throughout the day, they can be used for certain hedging strategies typically associated with stocks, such as buying on margin and selling short. 5th August 2013 Mutual Funds have been a popular way to invest for several decades while Exchange Traded Funds or ETF’s as they are commonly known, are relatively new...

Since ETF’s can be bought and sold in real time prices that change throughout the day, they can be used for certain hedging strategies typically associated with stocks, such as buying on margin and selling short.

5th August 2013

Mutual Funds have been a popular way to invest for several decades while Exchange Traded Funds or ETF’s as they are commonly known, are relatively new but are quickly gaining popularity for their low cost and lower operating expenses compared to mutual funds. ETF shares are created when an institutional investor or an “authorized participant” deposits a specific block of securities with the fund. This basket of stocks reflects the composition of an index such as the Nasdaq-100 or the S&P 500. Individual investors can buy and sell ETF shares only after they are listed on an exchange for e.g. NYSE.  Since ETF’s can be bought and sold in real time prices that change throughout the day, they can be used for certain hedging strategies typically associated with stocks, such as buying on margin and selling short.

Some of the differences between Mutual funds and Exchange Traded Funds are:

Attribute Exchange Traded Fund Mutual fund
Trading ETF’s can be bought or sold on an exchange at “real time prices”  throughout the day Mutual Funds can be bought or sold only once a day at the Net Asset Value (NAV). MF’s are not traded on the stock exchange and have to be purchased directly from the fund house
Trading Account You don’t need a share trading account to buy a mutual fund Since ETF’s trade on the market, you need a trading account to transact in them
Purchase and Sale ETF’s have to be bought through brokers or through an online trading account MF’s can be bought directly from the fund company, through a third party i.e bank, broker, financial advisor or a super market
Investment Limits Mutual funds have minimum investment limits, some of them as low as $ 1,000  and others higher ETF’s have no  minimum investment, you can even buy a single share from the market
Redemption Process Shares cannot be redeemed individually from the fund MF’s can be redeemed through the fund company at the end of day NAV, less applicable fees
Tax Implications ETF’s provide more tax savings to the investor Mutual fund also provides tax savings to the investor, but they may force unwanted capital gains distribution due to trading activity of other share holders
Expense Ratios Expense Ratios of ETF’s tend to be lower since they are passive in nature Expense Ratios on mutual funds are generally higher, because they are actively managed
Brokerage ETF’s will be garnished with brokerage fees. Since MF’s are bought directly from the fund house, there is no brokerage fee levied on it

ETF tax efficiency

ETF’s are more tax effective than mutual funds, its ability to decrease or avoid capital gain distributions comes from two differences, unlike mutual funds where shares are redeemed with the fund directly, ETF’s are traded on an exchange just like a stock. When one party sells the ETF and the other party buys on the exchange, the underlying securities with the ETF are not sold to raise cash for the redemption, as there is no gain in this process, the investor is not taxed.

On the other hand, mutual fund managers may be forced to sell portfolio holdings to meet the redemption demands of certain fund investors which may result in unexpected capital gain losses to the shareholders.

Unlike Mutual Funds, ETF’s may be highly leveraged, bought on margin or trade options, employ short selling and use complicated derivatives

– See more at: http://www.internationalfinancemagazine.com/article/Difference-Between-Mutual-Funds-and-Exchange-Traded-Funds.html#sthash.8TKSPMpw.dpuf

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