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An ETF is a cousin, if not a sibling, of mutual funds and index funds, says Kip Meadows, CEO and founder of Nottingham, a Rocky Mount, North Carolina, fund administration firm. An ETF’s composition — a diversified collection of securities — is similar to that of a mutual fund.
But this type of fund has a few differences, and some features that may make it especially good for a new investor.
The main difference between these funds and mutual funds is that ETFs trade on an exchange all day, just like an individual stock. In other words, you can buy shares of an ETF in the morning and sell it the same afternoon, says Eric Ervin, CEO of Blockforce Capital, an asset manager based in San Diego.
Investments are always somewhat complicated. There’s a lot of under-the-hood construction and regulation you don’t see unless you really go looking for it. But you don’t need to. You don’t have to build Big Ben when you just want to know the time, Meadows says.
The first ETFs were based on an index. These days, you’ll see a wide variety, some based on different countries and different sectors, such as oil and energy or technology. That’s helpful if you have specific views on how you’d like to invest your money, Ervin says.
Both ETFs and mutual funds have a lot of value. Our economy is focused on innovation, and more innovation will take place in ETFs over the next 10 years to 15 years.
CEO of Nottingham
ETFs generally don’t issue annual capital gains distributions, according to Crystal Stranger, president of 1st Tax, a tax advisory firm — that’s a win, come tax time. You will pay taxes on any gains when you sell, however.
One downside is you might be limited to large-cap stocks in some sectors or foreign stocks. That lack of exposure to mid- and small-cap companies could mean missing out on some growth opportunities as an ETF investor.
Mutual fund prices fluctuate throughout the day, but you can only buy them at the close of business. Say you want to buy a mutual fund comprised of tech stocks such as Apple. At 10 in the morning, you see that the price is pretty good. But you will have to wait till the market closes to buy it, and it can be tricky to nail down the price you want.
An ETF, in contrast, trades throughout the day. Like the price that morning? You can buy it right away, which is great for instant-gratification types.
You know all the ingredients
Mutual funds must post their holdings every quarter, and they can rebalance and change their composition frequently, without letting you know every single movement. Not so with ETFs.
“The day that change is made, you know the next day,” Ervin said. “We know every single day what the holdings in that ETF are.”