Exchange Traded Funds (ETFs) and mutual funds are collections of individual stocks, bonds, commodities, or other funds – or a combination of these.
One ETF or mutual fund can hold hundreds or thousands of individual securities, so diversification can be built in. Here's what you should know about these investment options.
Trade on exchanges, just like stocks. When you buy an ETF, you buy it from another investor.
Shares are purchased from a managing company, such as Vanguard or T. Rowe Price.
Usually passively managed, automatically tracking a pre-selected index, such as the S&P 500 or the Nasdaq 100, or a commodity such as gold or silver. Passive management usually means lower fees.
Actively or passively by a professional manager. Active management usually equals higher costs, but in a rough market, an active mutual fund manager can sell off riskier assets to reduce volatility.
Lower investment minimums. You can buy an ETF for the price of one share.
The minimum initial investment is typically a flat dollar amount.
More tax-efficient. Tracking an index usually doesn't require frequent trading, so you don't have capital gains until you sell.
More tax-efficient for index funds. Less tax-efficient for actively managed funds because managers constantly rebalance the fund by selling securities. Those sales create capital gains for shareholders.
0% to 37%. ETF dividends may be "qualified" or treated as ordinary income, depending on how long you've owned the fund. Qualified dividends are taxed anywhere from 0% to 20%. Non-qualified dividends are taxed at ordinary income rates, which range from 10% to 37%.
0% to 37%. Mutual fund dividends can also be qualified or non-qualified. Qualified dividends are taxed at rates ranging from 0% to 20%, rates on non-qualified dividends range from 10% to 37%.
The potential to
outperform the market