Exchange-traded funds (ETFs) and mutual funds are excellent options to diversify your investment portfolio. However, not everyone is aware of the difference between the two or how each option works. In this blog, we will explore the world of ETFs, explain what they are, and compare exchange-traded funds to mutual funds. Let’s dive in and discover more about these investment options.
What are Exchange-Traded Funds?
Exchange Traded Funds (ETFs) are a type of Index Fund that can help you diversify your financial portfolio. One benefit to utilizing ETFs is the fact that they can be day traded in a secondary stock market, similar to individual stocks. Another benefit to investing in exchange-traded funds is that the minimum purchase requirements are pretty low allowing you to easily purchase ETFs and begin your investing journey pretty quickly. ETFs can be traded above or below their Net Asset Value (how much the asset is worth) and are calculated daily.
Oh, and did we mention ETFs have tax benefits? Utilizing options like ETFs is a great way to be strategic with your investing strategy. But more on that later.
What are Mutual Funds?
Mutual funds are a type of professional-managed fund that allows a group of investors the opportunity to join forces on an investment. This group of people are the shareholders of the mutual funds that will receive the returns on the investments over time. The appointed fund manager decides which stocks to invest the money in over time. To get started, there’s often a minimum purchase requirement to buy into the fund.
There are many types of mutual funds: Stock, Bond, Hybrid, and Money Market Funds. Within a stock mutual fund, you have sector funds, growth funds, value funds, income funds, and index funds. The value of investing in mutual funds is that you’re able to choose which type of funds you want to invest in—and you get to diversify your investments out of the gate.
Keep in mind that if you invest in mutual funds, it’s typically a long-game investment. If you want to get more hands-on trading action with your investment, this may not be the right choice for you in this season.
Exchange-Traded Funds versus Mutual Funds: What’s The Difference?
Both ETFs and Mutual Funds provide a great way to easily diversify your investment portfolio. Here’s a quick guide to the differences (and similarities) of each at a glance:
Mutual Fund | Exchange-Traded Fund |
Higher Exchange Ratios | Low Exchange Ratios |
Professional Managed | Professional Managed |
Less Tax Efficient | More Tax Efficient |
Actively Managed | Passively Managed |
Pooled Investment Owned By A Group of Shareholders | Pooled Investment Fund Owned By A Group of Shareholders |
Tax Advantages of ETFs
One of the more enticing advantages of investing in an ETF is the tax advantages. When you invest in an ETF and then choose to sell, you’ll usually have to pay capital gains on any income earned. But since an ETF is owned by a group of shareholders, those investors aren’t usually affected by those trades.
If you choose to purchase and sell an ETF, the length of time you owned that asset will determine the amount of capital gains tax you’ll be required to pay. Usually, the longer you hold onto those assets, the less capital gains you’ll pay.
One of the benefits of investing with ETFs is the opportunity for other tax strategies like tax loss harvesting, having more control over how (or when) your gains are taxed, and in-kind redemptions.
Are ETFs A Good Investment?
Everyone’s investment and financial strategy is going to be different depending on your age, what your retirement goals are, and the amount of risk you want to take on when investing. An Exchange-Traded Fund is often a great way to diversify your financial portfolio while allowing you some tax advantages within your investment strategy.
If you’re interested in learning more about utilizing ETFs in your own financial strategy, we’d love to help. Talk with a SageSpring Wealth Partner about how ETFs can add to your investment strategy this year.
