How is an ETF different from a mutual fund?

Generally, both ETFs and mutual funds are managed by fund managers and are diversified across many different securities. Many of these funds are designed to track the performance of a major market benchmark or index. Often, mutual funds are actively managed, meaning they are managed with the expectation of beating the performance of an index. Such mutual funds tend to be much more expensive than ETFs. For mutual funds and ETFs that share the same objective, ETFs may still typically be less costly. Also, ETFs can be more liquid securities, are traded throughout the day like individual stocks, while mutual funds only trade once at the end of the day.

The performance of mutual funds is also more sensitive to the behavior of other investors - if a significant number of investors who own the mutual fund wish to sell their shares, the fund managers may be forced to liquidate securities at an inopportune time, which may adversely impact the remaining investors in the fund. In contrast, investors in highly liquid ETFs are not generally impacted by the buying and selling of other shareholders in the fund.

Lastly, Ellevest believes that mutual funds may create more tax consequences for investors.  Mutual funds may distribute capital gains even if you haven’t sold any shares, potentially creating unintended tax consequences. In contrast, investors of ETFs decide when to sell their shares and take capital gain distributions, providing ETF investors with more control of when taxable events occur. This allows investors to minimize and control the timing of their tax liability. This control may make ETFs more ‘tax efficient’ than mutual funds.

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