Buying puts can be an effective strategy to help protect your financial assets in a market downturn, however there are risks.
8 Ways to Compare Mutual Funds and ETFs
If you’re looking for a deep dive into advanced stock trading tactics, this is one blog you might want to skip. But if you’re looking for a comparison of mutual funds and exchange-traded funds (and how both differ from individual stocks), then read on. And if you like pictures, you can check out our chart below where you can quickly review the similarities and differences.
Mutual Funds, ETFs: What They Have in Common
- Diversification: Mutual funds and exchange-traded funds share the name “funds” for a reason: both consist of baskets of securities. Some mutual funds and ETFs might hold a few securities (like stocks or bonds), while others might hold thousands. A single mutual fund or ETF can offer diversification on a scale that most individual investors couldn’t afford if they had to purchase individual stocks and bonds.
- Professionally managed: Mutual funds and ETFs are overseen by managers who decide which securities will be held based on each fund’s investment strategy. In addition, even passively managed funds are professionally managed.
- Fees: Mutual funds and ETFs impose various fees, which are collectively expressed as an expense ratio. The overall performance of a fund generally equals the returns of all of the securities, minus the expense ratio. For example, if a fund has a 1% expense ratio, and its securities increase 5%, the return to investors would be 4%.
- Net asset value: ETFs and mutual funds have a net asset value determined by the total value of the underlying assets, minus fees, divided by the total number of shares. The name for this value is net asset value, or NAV.
Mutual Funds, ETFs: How They Differ
- Trading them. ETFs can be traded constantly on a stock exchange while the stock market is open at a price that can vary from the net asset value (though typically not by much). Mutual funds trade only at the NAV price. So if you place an order at 2 p.m. ET to buy a mutual fund, you will buy or sell at the NAV price at the 4 p.m. close.
- Order types. With ETFs you can generally enter the same orders as you would with stocks, such as placing limit orders or using options. Those types of orders are not available with mutual funds.
- Transparency. Mutual funds usually publish their list of holdings once a quarter; most ETFs publish their list each day.
- Minimum investment. You can buy as little as a single share of an ETF; mutual funds typically have minimum dollar amounts for buying initial and subsequent shares.
The Expense Ratio Nuance
In general, expense ratios are lower for ETFs than for mutual funds, but it might be important to understand why.
Most mutual funds are actively managed, which means they try to pick out a basket of securities designed to beat a benchmark (like the S&P 500). Most ETFs are passively managed, which means they attempt to track a benchmark by selecting the same stocks and in the same proportion as the benchmark.
Active management typically involves more trading (which results in more cost) than simply replicating a benchmark, so expenses are typically higher. However, there are passively managed mutual funds with lower expense ratios, and actively managed ETFs with higher expense ratios. So make sure to read the prospectus for each prior to investing.
In upcoming blogs, we’ll dig deeper into ETFs and mutual funds. Let us know in the Comment section if there are particular questions you would like answered.
Are you more likely to use ETFs or mutual funds to help build a diversified portfolio?
Investors should consider the investment objectives, charges, expense and unique risk profile of an exchange-traded fund (ETF) or mutual fund carefully before investing. A prospectus contains this and other information and should be read carefully before investing. A mutual fund prospectus is available through www.scottrade.com or through a Scottrade branch office An ETF prospectus must be obtained from the issuer.
Options involve risk and are not suitable for all investors. Detailed information on our policies and the risks associated with options can be found in Scottrade's Options Application and Agreement, Brokerage Account Agreement, in the Characteristics and Risks of Standardized Options booklet which can be downloaded from the Options Clearing Corporation website www.optionsclearing.com, ordered by phone at 888-OPTIONS, or obtained at a Scottrade branch office. Supporting documentation for any claims will be supplied upon request. Consult with your tax advisor for information on how taxes may affect the outcome of these strategies. Keep in mind, profit will be reduced or loss worsened, as applicable, by the deduction of commissions and fees.
The information and content provided is for informational and/or educational purposes only. The information presented or discussed is not, and should not be considered, a recommendation or an offer of, or solicitation of an offer by, Scottrade or its affiliates to buy, sell or hold any security or other financial product, or an endorsement or affirmation of any specific investment strategy. You are fully responsible for your investment decisions. Your choice to engage in a particular investment or investment strategy should be based solely on your own research and evaluation of the risks involved, your financial circumstances, and your investment objectives. Scottrade, Inc. and its affiliates are not offering or providing, and will not offer or provide, any advice, opinion or recommendation of the suitability, value or profitability of any particular investment or investment strategy.
Keep in mind that while diversification may help spread risk it does not assure a profit, or protect against loss, in a down market.
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