Understanding ETFs And Mutual Funds And Their Importance!

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When Exchange-traded funds or ETFs first came, they were labeled as the new kids in the investment world. But the tides have turned in Exchange-traded funds’ favor. They have gained such popularity that they are giving a stiff competition to Mutual funds.

Considering as such, both mutual funds and ETFs are viable choices for an investor. The problem is that today there are a number of mutual funds and ETFs available in the market. Therefore, an investor must understand the differences between the products in order to make relevant investment related decisions.

ETF or Mutual Fund

As the mutual fund vs. ETFs match rages on, Wells Fargo explains the similarities shared and difference found between the two before choosing one.

LEGAL STRUCTURE OF MUTCUAL FUNDS

Mutual Funds can be divided into two types:

Closed-End Funds

These types of funds give a specific number of shares only and no new shares are issued as the investor’s demand grows. Their prices are not decided by Net Asset Value (NAT) of the fund but by the investor’s demand. A share purchase is mainly down at a premium or discount to NAV.

Mutual funds

Open-Ended Funds

They are the most used mutual funds in the market. When it comes to open-ended funds, buying and selling of fund shares happens straight between the investor and the fund company.

Unlike closed-end funds, more shares can be issued as more investors buy into the fund, meaning that there are no limits on the number of shares the fund can issue. Federal regulations use marking to market (a daily valuation process), to adjust the fund’s per share price to display changes in portfolio (asset) value.

LEGAL STRUCTURE OF EXTERNAL-TRADE FUNDS

External-trade funds can be divided into three types:

Exchange-Traded Unit Investment Trust (UIT)

They are governed by the Investment Company Act of 1940, but they need to try to completely copy their specific indexes, limit investments in a single issue to 25% or less, and place extra weighting limits for diversified and non-diversified funds. UITs pay cash dividends on a quarterly basis instead of automatically reinvesting dividends.

ETF

Exchange-Traded Open-End Index Mutual Fund

Similar to UIT, they are also registered under the Investment Company Act of 1940 and the dividends are reinvested on the day of receipt and paid to investors in cash after every quarter. They allow security lending and can use derivatives in the fund.

Exchange-Traded Grantor Trust

Although they look similar to closed-ended fund, contrary to that, Exchange-Traded Grantor Trust is totally different. The investor owns the underlying shares in the company in which the ETF is invested. This includes the voting rights associated with being a shareholder. The dividends earned are not reinvested but paid to the shareholders directly. The condition is an investor must trade in 100-share lots.

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