Mutual Funds versus ETFs: What’s the Difference?

Since we maintain a long-term investment strategy that discourages individual stock-picking, we often utilize two types of investment products to implement our preferred investment philosophy: mutual funds and exchange-traded funds (ETFs). What are they, how are they different, and why do we use them?

Let’s start with the similarities. Both types of funds consist of a mix of many different securities and represent a common way for investors to diversify, hence, Multnomah Group’s preference for mutual funds and ETFs. This keeps trading expenses to a minimum, provides automatic diversification, and encourages long-term discipline.

There are key differences, though, in the way they are managed.

  • Mutual funds are priced once per day at the end of the day based on the underlying securities net asset value (NAV). Investors transact in the fund directly with the fund company to buy additional shares or redeem their shares in the fund daily.
  • ETFs trade on a public market, similar to stocks, throughout the day. Investors buy and sell shares with other investors in the public market and do not transact directly with the fund company.
  • Mutual funds can be actively or passively managed. Actively managed mutual funds can be less tax efficient for investors as the active management may result in higher realized capital gains that are passed through to investors.
  • ETFs are generally passively managed, resulting in greater tax efficiency for investors. The mechanism for creating and redeeming ETF shares also enables greater tax efficiencies for ETFs, although the specifics of the mechanism are highly technical and beyond the scope of this comparison.
  • Mutual funds can have a variety of share classes, each with a different expense ratio, making evaluating fees more challenging.

So, are mutual funds or ETFs better? Since their differences are mostly technical in nature, there isn’t a single, straight answer to that question. The answer depends on the specific investment objectives of a client, portfolio size and projected cash flows, tax-treatment of the account, and other factors. Both types of products are useful tools in creating a portfolio that meets your long-term goals, and we use both to create the best portfolio that matches your financial goals.

Multnomah Group is a registered investment adviser, registered with the Securities and Exchange Commission. Any information contained herein or on Multnomah Group’s website is provided for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Multnomah Group does not provide legal or tax advice.

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