Learn The Difference Between ETFs And Mutual Funds?

Answer 1

Rapidly gaining popularity among investors worldwide, exchange-traded funds are now a real alternative to the more traditional mutual funds trading. Both have advantages and disadvantages, both carry a serious risk for the investor, and both types of investments have several categories that need to be explored. Basically, mutual funds are simple and revolve around a certain stock option. ETFs are like complete portfolios that reflect the performance of an entire market index.

Two Types Of Mutual Funds

Closed-end mutual funds do not have an increasing number of shares available as demand grows. The prices are driven solely by the investor demand, not by the fund's net asset value.

Open-end mutual funds involve a direct purchase between the funding company and investors. The fund can issue as many shares as it wishes, and there is a daily valuation process regulated by the federal government. This daily procedure changes the share price according to the calculated value of the portfolio. This value is unaffected by the number of shares.

Three Types Of ETFs

A unit investment trust is governed by the Investment Company Act of 1940 and attempts to mimic or replicate a specific market index. A UIT pays cash dividends on a quarterly basis.

An ETF open-end index involves reinvesting of dividends on the actual date of receipt. The law allows for securities lending, and cash dividends are paid quarterly.

An ETF grantor trust is similar to a closed-end fund, but in this case the investor actually owns shares in the companies that the ETF is invested in. The investor also has voting rights as a shareholder. Dividends are not subject to reinvestment but instead are paid directly to shareholders.

Some Advantages Of ETFs

Because they are considered managed portfolios that are not involved in volatile daily price changes, ETFs usually have lower capital gains than mutual funds. Shareholders pay the tax on the turnover within a specific fund.

Stocks that are traded at a thin level are considered to be illiquid and are subject to higher spreads. This results in a price premium. ETFs are generally immune to this problem because the liquidity of this stock is not directly related to the daily trading volume. Instead, ETFs and their liquidity is parallel to the liquidity of the stocks within the market index. The primary concern for investors wanting to get involved with ETFs is the possibility that the fund itself will go out of business due to enormous losses. An unplanned liquidation of funds is to be avoided when trading ETFs.