While exchange-traded funds, or ETFs, and mutual funds are certainly related, and although ETFs are structured similarly to their industry counterparts, they each have unique roles and as such are treated as separate investment products. Mutual funds have been around since the early 1920s, and by 2007 were owned by about 50 percent of U.S. investors, according to a 2007 article on the Bankrate website. ETFs were introduced in the 1990s and have since come to represent about 33 percent of stock market trading, according to a 2012 article on the Barron's website.
Most ETFs are passively managed investment funds. They are designed closely to a specific broader market index and therefore deliver similar returns. Actively managed funds, which are built to beat the performance of some market indexes, were only beginning to surface in the ETF market in 2012, according to a 2012 article on the Market Watch website, and represent a small percentage of ETFs. Active management is much more prominent in mutual funds. Only 13 percent of equity mutual fund assets are invested in passive funds, according to a 2011 article on the Knowledge-at-Wharton website.
One of the key differentiating factors of ETFs from mutual funds is that the former trade in the financial markets similarly to stocks. As a result, the value of ETFs changes frequently throughout a trading session as investors buy and sell shares in the stock market. Mutual funds have a net-asset value, or NAV, that is typically calculated only once each day. As a result, investors who want to buy or sell shares do so based on that one calculation and are less likely to find as many short-term profit opportunities in comparison to what ETFs have the potential to provide.
There are generally higher fees associated with mutual funds compared with ETFs. One reason for this is for the actively-managed component that most mutual funds offer. ETFs are mostly passive, and as a result require less of an investment in trading expertise, research and administrative costs. Mutual funds also charge investors a fee for redeeming, or withdrawing, assets. ETFs -- given that they are traded like stocks on major exchanges -- do not charge redemption fees, although investors are subject to brokerage charges, according to a 2012 article on the Fox Business website.
While ETFs trade on major exchanges and are available for individual investors to purchase, only a small percentage of these index funds can be found in corporate retirement plans, many of which are administered by firms that sell both ETFs and mutual funds -- the latter of which generate higher profits for administrators. ETFs represent only 0.2 percent of retirement assets in 401(k) plans, while mutual funds represent more than half of retirement assets, according to Cerulli Research data cited in a 2012 article on the Wall Street Journal website.
- market woes image by John Keith from Fotolia.com