Understanding the Differences Between ETFs and Mutual Funds

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ETFs offer an advantage in capital gains

The burden of capital gains taxes is most often shared among members of a mutual fund. Your tax obligation is likely to be higher with a mutual fund that uses active management. ETFs use passive management instead and see fewer taxable capital gains as a result. When you wish to withdraw from an ETF, you receive “in kind redemptions” instead. This limits your exposure to taxes.

 

The costs associated with ETFs and mutual funds

Mutual funds often require entrance and exit fees, which can be quite substantial. If you remain in a fund for a very long time, these costs are less severe. However, ETFs usually provide both smaller management fees year over year combined with no fees to begin investing. For investors with large portfolios, they may find greater savings by trading in ETFs rather than a mutual fund. However, transaction fees within ETFs can quickly stack up, wiping out cost savings. As you can see, it can be a balancing act.

So which investment do I think is best? There isn’t a solid answer one way or another: in reality, it’s going to come down to your individual financial situation. An ETF could be the better choice for some investors, but both offer the advantages of diversification and a “hands off” approach for individual investors. Even so, the tax benefits and simplified structure of many ETFs can make them an appealing choice for the savvy investor. Weigh your options carefully and, of course, consider seeking professional advice.