ETFs combine the ease of stock trading with the diversification benefits of mutual funds. While ETFs, mutual funds, and stocks have similarities, understanding their differences is key to ensure you select the appropriate vehicle.
How similar are ETFs to mutual funds and individual stocks? Compare these three investment vehicles:
ETFs and mutual funds either seek to track or try to outperform the performance of an index, such as the S&P 500® Index. They provide access to many companies or investments in one single trade, removing single stock risk, or the risk inherent in being exposed to just one company.
This diversification across many securities can dilute the potential negative impact of poor performance that any one security may have, thus lowering the risk that an individual stock could hurt the portfolio’s overall performance.
Both ETFs and mutual funds have an expense ratio, which includes management fees and the fund’s total annual operating expenses. Historically, index ETFs have had a lower average expense ratio—0.46%,1 while index mutual funds have had a higher average expense ratio—0.64%.1 Individual stocks do not have an expense ratio.
Because ETFs and individual stocks are bought and sold on an exchange, they are both subject to a transaction fee (or commission). Mutual fund transactions do not incur commissions, but may incur other sales charges.
It’s important to consider the total cost of ownership (TCO) for any investment, both the expense ratio and the trading costs. ETFs now trade commission-free on many platforms, which can lower the total cost of owning an ETF.
You can find out more about TCO here.
Because investors can buy and sell ETF shares on an exchange continuously throughout the day, like individual stocks, ETF pricing captures the current market price. Their cost may be slightly more or less than their net asset value (NAV).
Mutual fund shares are priced once at the end of the trading day. Shareholders purchase and redeem shares at the closing net asset value of the fund.
Similar to individual stocks, with ETFs, there is no minimum investment requirement.2 An investor can purchase as few as one ETF share or as many as preferred. Mutual funds may require investment minimums of $2,500 or more.3
When an investor decides to sell ETF shares or individual stocks, any associated capital gains tax is paid at the time of final sale. This offers greater control on the timing of tax consequences.4
In contrast, when an investor decides to sell a share of a mutual fund, the fund manager may sell a portion of the fund’s security holdings in order to deliver cash in the amount of an investor’s position. This sale may generate a realized taxable gain, and taxes on those gains are absorbed by the remaining shareholders in the fund.
1 Morningstar Direct. Data as of 09/30/2019. Average Prospectus Net Expense ratio for index ETFs and open-end index mutual funds oldest share class as defined by Morningstar.
2 Subject to brokerage rules/costs/fees.
3 There are mutual funds that do not require investment minimums.
4 However, changes in an ETF’s underlying index could trigger the sale of securities which, in addition to transaction costs, may trigger capital gains distributions. In this scenario, any realized gains or losses are passed on to ETF shareholders. To ensure tax efficiency, ETF managers attempt to limit these types of transactions as much as possible.
Closing Net Asset Value
A mutual fund’s price per share value based on the closing market prices of the securities in the fund’s portfolio.
The current price at which an asset is bought or sold in the marketplace.
Net Asset Value (NAV)
The price of a share determined by the total value of the securities in the underlying portfolio, less any liabilities.
S&P 500 Index
A popular benchmark for U.S. large-cap equities that includes 500 companies from leading industries and captures approximately 80% coverage of available market capitalization.
State Street Global Advisors Funds Distributors, LLC does not offer securities trading. SPDR ETFs may not be available for trading on a commission free basis on the brokerage platform on which you trade.
ETFs trade like stocks, are subject to investment risk, fluctuate in market value and may trade at prices above or below the ETFs net asset value. Brokerage commissions and ETF expenses will reduce returns.
Investing involves risk including the risk of loss of principal.