As you get more conversant with the investment space, you will encounter these two types of funds: mutual funds and ETFs (exchange-traded funds). In this article, we bring both side by side and here’s what you need to know about them.
A mutual fund is an investment entity that pools funds from investors to invest in securities such as stocks, bonds, and money market instruments.
According to The Securities and Exchange Commission (SEC), Nigeria has about 107 Mutual Funds across these several fund types: Bond Funds, Equity-Based Funds, Ethical Funds, Exchange Traded Funds, Fixed Income Funds, Infrastructure Funds, Mixed Funds, Money Market Funds and Real Estate Funds.
Exchange-Traded Fund (ETF) is an investment fund that tracks the performance of indices or securities (such as shares, bonds, etc.). ETFs are listed on a stock exchange and traded like stocks. Investors can diversify their investments across asset classes such as Equities, Fixed Income, Commodities, Currencies, International Markets, Multi-assets, etc.
The Nigerian Exchange (NGX) is the leading ETF in West Africa and one of the largest in Africa.
Mutual Funds vs ETFs: Similarities and Differences
Both are similar in that they are both profitable investments that pool investor money into a collection of securities allowing the investors to have a diversified portfolio.
Mutual Funds have been around for years, while ETFs are relatively new. ETFs offer the same diversification benefits as mutual funds but often at a much lower cost to the investor. Here are more key differences between Mutual Funds and ETFs.
1. How they’re run
Mutual funds are run by professional fund managers who attempt to beat the market by trading stocks. This is called actively managed funds and it means a slightly higher cost for investors.
On the other hand, ETFs are passively managed funds. Mutual funds outperform ETFs in the short term but may not realize as much returns compared to ETFs over the long term.
2. Expense ratio
An expense ratio is how much investors pay each year as a percentage of the amount invested to own a fund.
Passively managed ETFs have relatively lower expense ratios compared to actively managed mutual funds. However, don’t always assume ETFs are the cheapest when considering your investment options.
3. How they’re traded
ETFs usually track an index and are traded throughout the day like stocks, with prices based on demand and supply. On the other hand, mutual funds are priced and traded at the end of each trading day.
4. How they’re taxed
When you buy an ETF, you won’t pay capital gains taxes unless the shares are sold for a profit. Mutual funds are actively managed and often bought and sold more frequently. When the shares are sold for a gain, the capital gains taxes are transferred to everyone with shares in the fund, even if you’ve never sold your shares.
5. The minimum investment
ETFs can be purchased by the share and hence, have a low cost of entry. Mutual funds have higher costs of entry. However, on Cowrywise, you can invest in a mutual fund with any amount.
|Traded at the end of each trading day. Buyers and sellers get the same trading price.||Traded throughout the day. Purchased on a stock exchange, so you can expect daily fluctuations.|
|Have a higher cost of entry and a minimum initial investment that has nothing to do with the fund’s share price; this could be because they are only traded once a day.||Don’t cost so much, and the minimum purchase could be as little as one share.|
|Actively managed by a professional fund manager, and this often means the investors get a higher cost.||Passively managed, but a few are actively managed, and these few also result in a higher cost.|
|Have a lower tax efficiency.||More tax-efficient.|
|They are set up with automatic|
|They do not require automatic transactions.|
Which one is better? Mutual Funds or ETFs
It depends. Before deciding which works for you, consider factors like risk tolerance levels, tax sensitivity, investment goal, and time frame. Mutual funds and ETFs are equally low-risk investments. Both provide you with diversification.
Mutual Funds are better when you want to invest in different opportunities, mostly with foreign companies and other kinds of securities. ETFs have low fees and lower minimum purchases. However, don’t always assume it is low-cost. Be careful to also look for potential fees and make your comparison.
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