Question

Why do you think mutual funds and ETFs are such popular investment vehicles? Name three biggest differences between mutual funds and ETFs? Which of the two (mutual funds vs ETFs) is a better tool for long term investing (such as retirement) and why?

Answer 1

Mutual funds have been popular investment vehicles as a lot of new i.e. beginners are coming to markets for investments into various tools. But, the problem here is that they don't know which stocks to pick as the process is very complex. Mutual Funds assume the risk and the liquidity needs of the buyer and invest accordingly in funds with different terms. Mutual Funds offer professional management i.e. they have a group of professionals who analyze which stocks are better to invest at what time. Mutual funds also help in diversification of stocks i.e. they believe in investing in various stocks of different risks to balance the risks from the investment.

ETFs are exchange traded funds i.e. they are traded on stock exchange. The funds include stock which are traded close to net asset value. The benefits one gets from ETFs are lower costs, diversification, tax efficients, etc. An investor can purchase diverse assets at a point of time. ETFs have several advantages over mutual funds since they offer flexibility in trading on stock market, short and long positions can also be taken, the costs associated are also less than mutual funds.

Differences between mutual funds and ETFs :

1. Exchange of ETFs are not considered sales and a taxable event does not occur in ETFs but it occurs in Mutual Funds and the point of tax efficiency of ETFs comes in.

2. Trading of ETFs can be done throughout the day while that of Mutual Funds can only be done at the end of the day.

3. ETFs are traded on stock exchange whereas mutual funds are managed by professionals who invest their expertise to invest funds collected by various investors who rather than investing firectly invest in mutual funds.

The better out of the two for a person is decided based on the needs of the person i.e. the investor. The investment objective of a person decides which investment is better for him. One has thier own liquidity and risk needs. Expenses of mutual funds are higher. An investor who is active and who want to take less risks should invest in ETFs and vice versa. Both ETFs and Mutual Funds have their own benefits for different investors.

Mutual Funds are better for long term investing as ETFs are traded just like shares and the investor has to use his own knowledge to invest, but if the investment is to be done for a long term mutual funds should be the choice as the experts use their own knowledge to generate greater returns by investing in different portfolios.