Mutual Funds and ETFs

Mutual Funds and ETFs are both used by investors to make diversified portfolios. 

Mutual Funds: Mutual Funds can either be Open-ended or Close-ended Funds.

• Open-ended Funds are the most popular and there is no limit on the shares that the fund gives out. The number of shares does not impact the value of each share, and after each trading day, the fund is re-valued.

• Closed-ended Funds is not valued by the NAV and their price is determined by investor demand. They limit the shares that the fund gives out and as demand increases, they stop selling shares. The cost of these shares might be less than the NAV as a discount.

ETFs: ETFs cost less, are sold as stocks, and can be sold short. This creates an opportunity for short-term investors and arbitrage (a.k.a. buying and selling a stock at the same time in different markets to make a profit). 

ETFs have three types of funds:

• Exchange-Traded Open-End Index Mutual Funds allow security lending, derivatives, and dividends are automatically reinvested, then paid to shareholders in cash every quarter.

• Exchange-Traded Unit Investment Trusts (UIT's) limit investments for one issue to less than 25%, limit the weight of diversified and non-diversified funds, and strive to replicate their specific indexes. Dividends are not automatically reinvested, however, they are still paid to shareholders in cash every quarter.

• Exchange-Traded Grantor Trust Funds are similar to closed-ended funds. Specifically, investors are required to trade in 100-share lots and the shares of this type of fund are owned by an investor. Although the structure of the fund stays the same, this investor has voting rights as a shareholder. Dividends are not automatically reinvested, however, they are still paid to shareholders in cash every quarter.

Comparisons:

• ETFs are traded like stocks. Mutual Funds are purchased at the end of a trading day based on its net asset value (NAV).

• ETFs are based on a simple marking index and are observed while Mutual Funds are actively managed by a fund team. They actively buy and sell stocks. Because of this, Mutual Funds have a higher minimum cost to purchase (in the hundreds or thousands).

• ETFs can realize less capital gains than Mutual Funds because they are passively managed, however, they can have more tax advantages.