Fidelity: Mutual funds vs. ETFs: Which is right for you?

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Today's investors face what seems like an ever-growing variety of investment choices, with new mutual funds and exchange-traded funds (ETFs) continuing to arrive.

Trying to make sense of these different products doesn't have to be overwhelming. Here is what to expect, and some factors to consider as you weigh your investment objectives.SourceMoneyGuru-https://www.mgkx.com/4667.html

Fidelity: Mutual funds vs. ETFs: Which is right for you?SourceMoneyGuru-https://www.mgkx.com/4667.html

Different products, different experiences

As you consider ETFs and open-ended mutual funds, it is important to recognize how the vehicles' similarities and differences may influence your investing experience. Buying and selling, pricing, disclosure, costs, holding-period return, and tax implications can all be different (see the table below).SourceMoneyGuru-https://www.mgkx.com/4667.html

For example, unlike with a traditional open-ended mutual fund, the price of an ETF is set throughout the day. Higher demand from investors can result in the shares trading at a premium (compared to the value of the stocks that the ETF holds), and falling demand could cause the ETF to trade at a discount (compared to the value of the ETF's holdings). This continuous pricing and the ability to place limit orders means the ETF's performance for any given time period is based largely on the market price return during the holding period, rather than on the ETF's net asset value (NAV)—the value of the stocks held by the ETF.SourceMoneyGuru-https://www.mgkx.com/4667.html

Comparing ETFs and open-ended mutual funds

Exchange-traded funds Open-ended mutual funds
Buying and selling
  • ETFs are continuously priced throughout the trading day, and investors buy and sell them in the secondary market (i.e., the exchange on which the ETF trades)
  • ETF investors place orders through a broker; this allows them to place limit, stop-limit, and short-sale orders, and to trade on margin
  • Investors transact directly with the mutual fund company
  • Mutual fund investing does not require a brokerage account
  • Investors cannot buy mutual funds on margin, or set price limit orders
Pricing
  • Share prices fluctuate during the day on a stock exchange and have bid and offer prices
  • Price may trade above (premium) or below (discount) the NAV
  • All shareholder orders receive the same daily price—the NAV—calculated at 4:00 p.m. Eastern time
Disclosure
  • Daily disclosure of portfolio holdings to market participants
  • Estimated value of underlying holdings, known as the Indicative Optimized Portfolio Value (IOPV), released to the exchange every 15 seconds during trading hours
  • Disclosure of the number of days shares traded at a premium/discount during the previous year
  • Disclosure of performance at NAV and market
  • Generally, delayed monthly or quarterly disclosure of portfolio holdings
  • Disclosure of NAV performance
Trading costs*
  • Brokerage commission plus the difference between the bid and asking prices—the spread—on each buy and sell order
  • None for a no-load fund when bought directly through a fund company
Holding period return
  • Market price return (plus distributions)
  • Change in NAV (plus distributions)
Tax implications
  • Possibly more tax-efficient, because investor trades can be matched on the secondary market
  • When investor redemptions are not offset by cash inflows from investors, the redemptions can trigger portfolio trading, which can have tax implications for shareholders
* ETFs and mutual funds are subject to management fees and other expenses.

Which vehicle is right for an investor?

Typically, the best way for an investor to choose an investment is to use their own goals, financial situation, risk tolerance, and investment timeline to create a strategy. Using that perspective may help to identify appropriate investment vehicles. Consider the following types of investors and their varied objectives.SourceMoneyGuru-https://www.mgkx.com/4667.html

Active investor

Fidelity believes in taking a long-term view of investing. But some people choose to be more active, accepting the risk and costs of buying and selling securities more frequently. If you prefer to manage your own accounts and want to trade during market hours to implement your preferred investment strategies, ETFs can offer the flexibility to meet your needs. Similar to stocks and other types of investments, ETFs can be traded throughout the trading day and on margin. Investors also have the ability to set limit orders and sell short. Most open-ended mutual funds can only be purchased at their closing prices, or NAVs. ETFs offer transparency, allowing investors to review holdings daily and monitor portfolio risk exposures more frequently than with traditional open-ended mutual funds.SourceMoneyGuru-https://www.mgkx.com/4667.html

For the active investor, ETFs may may satisfy the investor's need for more trading flexibility and holdings transparency.SourceMoneyGuru-https://www.mgkx.com/4667.html

Long-term investor

Consider investors weighing options for their long-term investment goals. Fidelity believes that short-term trading is generally not an appropriate savings strategy. With a long-term view, investors may not want to devote a lot of time to worrying about the intricacies of an active trading strategy; they might have little use for the potential of buying or selling shares during the day; and they would likely want to minimize transaction costs for regular purchases.SourceMoneyGuru-https://www.mgkx.com/4667.html

Many open-ended mutual funds are available with no loads, no commissions, and no transaction fees. Many brokerages and banks offer automatic investing plans that allow regular purchases of mutual funds. These programs generally do not exist for ETFs. Moreover, open-ended mutual funds are bought and sold at their NAV, so there are no premiums or discounts. While an ETF also has a daily NAV, shares may trade at a premium or discount on the exchange during the day.2 Investors should evaluate the share price of an ETF relative to its indicative NAV.SourceMoneyGuru-https://www.mgkx.com/4667.html

Finally, any tax benefits that may exist for an ETF are irrelevant for someone saving in a tax-deferred IRA or workplace savings account, such as a 401(k), since taxes are paid upon withdrawal.SourceMoneyGuru-https://www.mgkx.com/4667.html

For the long-term investor, a traditional open-ended mutual fund could be an investor’s preferred option due to low transaction costs and automatic investing options.SourceMoneyGuru-https://www.mgkx.com/4667.html

Investors in a high tax bracket

Investors in a high tax bracket who are saving in a taxable account, like a brokerage account, may be interested in investments that offer tax efficiency for their taxable assets. In this scenario, if an investor finds that an open-ended index mutual fund and an index ETF are similar relative to their investment objectives, passive investments—index funds and passive ETFs—have the potential to be more tax-efficient than active funds and active ETFs.SourceMoneyGuru-https://www.mgkx.com/4667.html

Relative to actively managed mutual funds, some actively managed ETFs offer potential tax advantages.3 However, we caution investors against making long-term investment decisions based solely on any potential tax benefits. Investors should evaluate how an investment option fits with their time horizons, financial circumstances, and tolerance for market volatility, as well as cost and other features.SourceMoneyGuru-https://www.mgkx.com/4667.html

Investors in a high tax bracket may choose ETFs to take advantage of potentially greater tax efficiency.SourceMoneyGuru-https://www.mgkx.com/4667.html

Summary

While mutual funds and ETFs are different, both can offer exposure to a diversified basket of securities, and can be good vehicles to help meet investor objectives. It is important for investors to pick the best choice for their specific investing needs, whether an ETF, an open-ended mutual fund, or a combination of both.SourceMoneyGuru-https://www.mgkx.com/4667.html

Here are some points to consider when weighing vehicle options:SourceMoneyGuru-https://www.mgkx.com/4667.html

  • Trading Is it important to be able to execute fund trades at prevailing prices throughout the trading day? Consider ETFs.
  • Transaction costs Would you prefer trading a fund at NAV without paying a load, and avoiding the potential of paying a premium at purchase (discount at sale)? Consider ETFs or no-load mutual funds.
  • Margin Do you like the flexibility of trading on margin? Consider ETFs.4
  • Automatic saving Does your investment strategy include dollar-cost averaging? Consider the automated savings features of mutual funds in brokerage accounts.
  • Transparency Do you want to know a fund’s holdings each day? Consider ETFs that offer holdings transparency.
  • Cost Make sure to consider all costs and expenses related to any investment vehicle.
  • Diversification Do the benefits of both ETFs and mutual funds have the potential to help meet investment goals? Consider building a portfolio incorporating both types of vehicles, including other types of investments, to gain exposure to different asset classes.
SourceMoneyGuru-https://www.mgkx.com/4667.htmlSourceMoneyGuru-https://www.mgkx.com/4667.html
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