What is the difference between Mutual Funds and ETF's ?

Question

I am looking for answers concerning:

1) Min investment needed in most cases

2) How to Trade

3) Risk perscpective

4) In general how are they different

5) Anything more I need to know while investing

Your help will be much appreciated.

Thanks,

Karan

Answer 1

Actually,  the term ETF means exchange traded fund.  The meaning today has been taken over by index funds which are part of the collection but not all of the collection.  The term also applies to closed end funds some of which have been trading long before index funds were ever invented. ETFs are a sub-category of mutual funds.  There are at least two other broad categories--no load open end and load open end some of which are also index funds.

How are they different?  

ETFs are sold by stock brokers.  You have to have a brokerage account to buy them.  You can buy as little as one share, but you do have to pay a brokerage commission each time you buy and sell.  The index sub-class of ETFs are unmanaged funds more or less.  Some are more managed than others depending on the index that has been concocted for them to track. There are well over 600 currently. They all track some pseudo index.  The main selling point of index funds is low expense ratios.  Some expense ratios however are considerably lower than others.  Some have expense ratios that are as high as managed funds.

Closed end funds, the other etfs, are managed funds.  With these stock is issued to the public through an IPO and there are a fixed number of shares outstanding.  That is not the case with an index funds which have a facility to continually issue and redeem shares.  Because there are a fixed number of shares outstanding the share price can and does vary greatly from the net asset value, possibly by 20% or more is certain cases depending on supply and demand.   Interestingly there are about as many closed end funds as there are index funds in the ETF universe.  They too come in many different varieties.  Some have been in existance for a long time GAM and ADX since before the crash of 1929.  That is a long time.

No load open end mutual funds are best purchased directly from the fund company.  They are purchased at net asset value after the stock market closes on the day the order is entered and funded.  They can also be purchased through a stock broker but the broker may charge you a fee to purchase the fund, sometimes a considerable fee.   Generally, there is a minimum purchase amount.  It varies from fund to fund.  A common minimum is $2500, but after the initial purchase additions can be made to the fund in perhaps $50 minimum amounts.  There are no fees if these funds are purchased directly from the fund company.  Some companies with a wide variety of funds to choose from are Fidelity,  T Rowe Price,   Vanguard, and American Century.  There are many others besides.  

The final sub-category is load open end funds.  These are sold by stock brokers and have a sales charge either on  the front end, the middle end, or the back end.  Very confusing.  The sales charge is to pay the stock broker for peddling the funds.  But there are actually some good funds that are load funds.  American Funds family is one of the most popular and also has some of the best funds.  They generally have a lower minimum purchase price.  American Funds minimum is $500.  

Many fund families have an automatic investment plan where if you sign up you aggree to have the fund deduct automatically a minimum of $50 a month from your checking account to invest in the fund.  That way you do not have to come up with the $2500 minimum investment amount.  T Rowe Price has such a plan.  

You do not trade mutual funds in general, although I am certain that some people do trade ETFs.  Open end funds discourage trading.  They are designed rather for investing, at least the open end variety.  If you do want to trade ETFs, you would trade them like you would trade any other stock. They can be bought and sold at will just like a stock.  

Risk perspective.  Risk varies with the particular fund.  Some are much more risky than others.  Some of the Index ETFs are extremely risky such as RDX for example which is a 2x short fund.  Others which are short term U S government T Bill funds are much less risky, such as BIL

Answer 2

Mutual funds are actively managed and can incur more taxes, while ETFs just follow an index. Have no active buying and selling within the fund and result in slightly lower tax overhead.