What is an Exchange Traded Fund?
Mutual funds and exchange traded funds (ETFs) both were created from the basic concept of collective fund investing, oftentimes adhering to an passively, index-oriented approach that attempts to follow or mirror representative market benchmarks. Mutual funds are very diverse in terms of how they operate and what types of risks they may not carry; however, some similarities do exist. Mutual funds are pools of money that investors put together in order to earn returns from the collective investments of other investors. Unlike mutual funds that are usually made up of a single investment, ETFs have several underlying investments that are chosen based on the investment objectives of the investor and the management team. Additionally, ETFs are usually traded on national exchanges and have much higher trading volume than their more traditional counterpart mutual funds.
While both types of funds and ETFs generally follow similar structured approaches, there are important differences between the two that can affect how an investor thinks about the two. For example, both types of funds and ETFs typically include common share classes that are bought and sold on the same day. Common share classes in mutual funds are usually chosen from a list that is selected based on the asset value, risk level, and expected return. The difference between a mutual fund and an ETFs common share class is that the investments of an ETF are not limited to any single company and can involve multiple companies or industries.
Investors interested in both types of funds and ETFs should be careful to make sure that the investment portfolio they are building will be able to sustain their performance if the market moves against them. Some mutual funds will offer excellent growth opportunities while others will suffer severe losses due to market fluctuations. Therefore, a careful investor will want to be aware of which investments will be most profitable during different times of the year. Finally, while both types of funds and ETFs typically have the advantage of being easy to purchase and sell, it is important for investors to be aware of the tax benefits that they can enjoy by investing in ETFs. These benefits can be especially important for higher income individuals who are looking to minimize their taxable income.