Many people are surprised to learn that exchange-traded and mutual funds have much in common. There are quite a few similarities between them. However, the more you learn about the two, the better you will understand their differences to help you make investing choices better suited for your financial planning needs and comfort zone for risk.

Basics of Mutual Funds

Mutual funds and ETFs are collections of individual stocks and bonds, usually managed by professionals. Mutual funds gather money from various shareholders to invest; in return, the shareholders own a portion of that investment. These funds are suitable for novice investors or busy professionals who want professionals to diversify their portfolios and manage risks based on their preferences.

Different Types of Mutual Funds

There are quite a few investment options when choosing mutual funds. These are among the most common types of mutual funds investors can choose from today.

• Stock funds.
• Bond funds.
• Hybrid funds.
• Money market funds.
• Income funds.
• Specialty funds.

Each type of fund is one that certain types of investors find appealing. Each one carries its mixed bag of risk vs. reward. Working closely with an advisor can help you determine which promises the best return on investment and which types of funds mix best with your current holdings and investments.

Basics of ETFs

ETFs might be unfamiliar to some investors, but they are rapidly gaining popularity. They combine elements of both mutual funds and individual stocks. ETFs are suitable for those who want to start with a smaller investment. Although professionally managed, ETFs offer investors more control than many mutual funds. Many ETFs function like index funds, but they can be traded throughout the trading day, unlike the typical index fund.

Different Types of ETFs

Like mutual funds, there are many different types of ETF funds investors may select when investing. These are some of the more common ETFs on the market today.

• Commodity funds.
• Fixed-income funds.
• Equity funds.
• Currency funds.
• Specialty funds.

Each one offers its unique strengths and weaknesses from an investment perspective. Investing in ETFs can help you diversify your overall portfolio, helping to compensate for riskier investments in other areas of your investment portfolio.

Comparison of Mutual Funds and ETFs

Mutual funds and ETFs operate similarly in many aspects but have some key differences. Mutual funds often have significant fees, whereas ETFs, being directly traded, typically incur lower brokerage commissions than mutual fund fees.

Mutual funds can only be purchased once a day after the markets close, while investors can trade ETFs throughout the trading day. This flexibility makes ETFs more liquid and transparent than mutual funds, providing investors more versatility. Additionally, ETFs often have lower entry costs for investing. However, some investors find it challenging to sell their ETFs once they've invested. Another concern is the spread; premiums and discounts can change the value of the ETF at any time. You could face financial losses if you purchase at a premium and sell at a discount.

Buying/Selling Mutual Funds and ETFs

For the most part, buying and selling mutual funds and ETFs is a straightforward process. The pooling of resources for the funds allows people to get involved in the trading process with a smaller investment, and the fact that professionals manage the funds makes this type of investment a beginner-friendly option. However, it does not absolve you of the need to conduct your research to learn about the process and which types of investment are best for your financial goals and the money you have available to invest.

Tips for Mutual Fund/ETF Investors

The best advice you can get when investing in mutual funds, and ETFs is to stay on top of your investments. Ensure you're tracking your investments, aware of earnings (and losses, if any), and that you report the appropriate information to the IRS. Ensure you know the tax requirements for mutual funds and ETFs and that you report dividends correctly.

Also, resist the temptation to invest in companies based solely on shared values or product appreciation. Instead, put your money where it is most likely to earn the greatest possible ROI. Working with a financial advisor can help you make sound investment choices.

Takeaway

Both mutual funds and ETFs represent sound investment choices in a well-rounded portfolio. With that in mind, it is essential to understand their benefits and limitations and have other types of investments and assets to draw from for faster growth and reduced risk.