What Are Mutual Funds, Index Funds and ETFs? A Guide for the Confused

By Samuel Taube What are mutual funds, ETFs and index funds? You may know that they’re all investment vehicles containing a basket of stocks, bonds or other assets.

But do you know the differences between them?

The three fund types serve similar purposes, fundamentally. They allow you to invest in a diversified portfolio of assets that you might not otherwise be able to gather yourself. But it’s important to understand the features that make each fund type unique. Let’s get a precise definition of mutual funds, ETFs and index funds.
What Are Mutual Funds?
Mutual funds are the oldest variety of investment fund. Like the other types, they’re vehicles that pool money from investors to buy securities. This basket of assets is priced and sold to the public on a daily basis.

The daily basis part is an important distinction. Unlike the other fund types that we’ll discuss in a moment, the price of a mutual fund changes exactly once a day. In an actively managed mutual fund, the managers may trade the assets inside the fund throughout the trading day. But you can’t make money trading shares of the fund intraday.

That’s part of the reason mutual funds are so popular for retirement planning. They’re not good for day traders, but they’re great for savers who want to grow their money over a long period of time.

Mutual funds come in a few flavors. Closed-end mutual funds are the simplest type. They have a fixed number of shares that can be bought or sold only when they’re available on the market. There are also open-end funds, which can create and retire new shares based on investor demand. And then there are unit investment trusts (UITs), which are static portfolios of securities with no management.

Mutual funds have many advantages. They allow investors to buy into a diversified portfolio of high-value assets without having to manage that portfolio. However, that convenience comes at a price… Mutual funds (especially actively managed ones) often charge fees that may eat away at returns.

Another disadvantage of mutual funds is their tax inefficiency. Money in a mutual fund is usually tax-exempt as long as it stays invested. But when a mutual fund sells some of its portfolio at a profit, it is required by law to distribute those profits to shareholders. Those payments are taxable.

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What Are ETFs?
In very simple terms, an exchange-traded fund is like a mutual fund except that its price changes “live” on the market. Instead of being priced once a day, its price fluctuates with the market. This allows ETFs to be actively traded throughout the day.

Just like mutual funds, ETFs are baskets of stocks, bonds or other investments. And they come in many varieties. Some ETFs are actively managed, while others are passively managed or unmanaged. And they can contain a wide range of securities.

Two notable types of ETFs are leveraged ETFs (which track some multiple of the price of their underlying assets) and inverse ETFs (which track the opposite of their underlying assets). These funds give traders the ability to amplify …read more

Source:: Investment You

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