ETFs and Mutual Funds
Updated: Jul 26, 2020
Similar but different
ETFs and Mutual Funds are often used interchangeably, but there are a couple of distinct details that one must know to properly distinguish these two funds.
ETF (Exchange Traded Funds) are securities that contain a collection of securities, such as stocks, that often track an underlying index. These securities are traded on exchanges on a regular basis just like stocks. Because of the diversity of an ETF, they tend to be less volatile than an individual stock. Due to the lack of volatility, ETFs are often viewed as long-term stocks, as well as, safer investments.
An ETF can contain hundreds or thousands of stocks across various industries, or it can be specific to one particular sector. There are many different types of ETFs, but Industry or Sector ETFs are amongst the most popular. These ETF's focus on a particular industry like technology. Invesco (QQQ) is one of the most widely traded ETFs. This fund has a focus on technology and holds some of the largest tech companies like Apple (AAPL), Microsoft (MSFT), and Amazon (AMZN). Based on the performance of the companies that are part of the ETF, the value fluctuates.
Mutual Funds are often confused with ETFs. Mutual funds are funded by investors who pool
their money together. Based on your contribution, you are given equity in the pool. The pool is then used to invest in securities like stocks, bonds, money market instruments, and other assets. These funds are actively monitored and handled by professional money managers, to generate capital gains for the investors. A mutual fund is both an investment and an actual company. This dual nature may be confusing, but it is no different than how an investor buys a share of Amazon. When an investor buys a share of Amazon, they are buying into the company and its assets; similarily, an investor buying into a mutual fund is buying partial ownership of the fund. The difference is that Amazon's purpose is to provide services for people, whereas a mutual fund's purpose is to make money off investments.
Mutual funds cannot be traded like stocks and are purchased at the end of each trading day based on the calculated price.
ETFs and Mutual Funds are both great ways for investors to get some skin in the game with low risk. These two terms are commonly used in the investment business and are important to be able to understand.