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What are the differences between funds and ETFs?
Generally, they are the same thing — with a few differences in the details, of course. It’s kinda like asking what’s the difference between a sandwich and a burger — some might refer to them interchangeably, given how they are just some breads layered with proteins, veggies, or whatever you put in there — while others may look into the details of both dishes and find remarkable differences in the details. Such are funds and exchange-traded funds (ETFs).
Before we start, it’s vital to note that there are a huge variety of funds nowadays, many of which are quite different from each other. In this context, we’ll look at the general sense of funds.
How are they similar?
They are both funds: In general, they are funds. It is a type of financial instrument where instead of you taking your money and buying stocks, currencies, commodities, or whatever, you give that money to someone who will do that for you — but it’s not just you! That someone pools money from many people, and the bulk of money that you and many other people handed to him/her will be managed by that person, he/she will decide where & what to invest in, and by how much. That is generally how funds work.
Fees: Given that the person will do the thinking for you, they’re not going to do it for free. In general, be it investing in the classic funds or ETFs, or whichever fund you might encounter in your life, there would usually be fees involved. It would even be ironic to expect such charity from capitalism. However, there are differences in the fee structures.
They have different ‘themes’: Before this — like waaaaayyy before this, many funds would just sell you the idea that they can make money for you. Now, you can see many different funds and ETFs with many different selling points. Some are based on industries, like tech funds that only invest in the tech sector, or Sharia-compliant funds, a type of fund that would only consist of Sharia-compliant financial instruments.
You get the benefit of investment: Although you might not be considered the actual owner of some financial instruments, you hold the rights over them. For example, you put your money in a fund, and your fund purchases shares in Apple. When Apple announces dividends, the dividend will be named to the fund, which means that the fund will receive the money, although that money will actually be given to you (depending on how much money you put in that fund).
Pro tips: This might affect how your tax payment will play out. Since the money is not considered a dividend (on paper), it may affect things like tax exemptions, etc.
How are they different?
How they are sold to you: Funds are offered by whoever created these funds. For example, JPMorgan created a fund. You can go to JPMorgan (or just their website) and tell them that you want to purchase a few shares of that fund. Of course, some funds are not exclusively sold by the creator of said funds — they can be found in brokerage apps, etc. ETFs are sold in the exchange, just like stocks are. So, you buy ETFs just like you buy stocks.
This brings about another thing, which is the timing for trades. Since ETFs are sold in the exchange, the timing in which you can purchase ETFs follows the exchange timing. As long as the market is open, your order can be filled during that time. As for funds, they’ll only be executed when the market has closed. For example, if you placed an order for a fund on Monday morning, it will only be executed once the market closes on Monday (usually at night).
What will that mean? It may affect the price that you get to buy/sell at, for better or worse.
Fees, again: Both will impose fees, but funds would usually have more kinds of fees in it, such as transaction fees, distribution charges, and transfer-agent costs, while ETFs would usually have lesser types of fees imposed. In many cases, ETFs would have you paying less fees compared to funds. However, there are funds that are cheaper and better than ETFs as well — it’s all about how keen your eyes for a good bargain are.
Taxation: To keep it simple, the taxation rules when it comes to purchasing ETFs is like when you’re purchasing stocks. As for funds, if you gain from selling your funds, it would usually be considered taxable capital gains (depending on your country), while dividends received from funds can vary based on country. Some consider it as dividends, while others may consider it as a capital gain — which can give different taxation outcomes.
You can short-sell ETFs: ETFs are like stocks, and you can treat them like one. You can short-sell ETFs just like you can with stocks!
Actively/Passively managed: Usually (although not always) funds are more widely known for being actively managed — which is where the fund manager would constantly buy and sell to maximize the fund’s profitability. ETFs are more known to be passively managed, in which there are buys and sells within it (we call it rebalancing), but they are seldomly done — compared to how a fund would. However, among funds themselves, there are also funds specifically known for being passively managed, and the fees are way less too.
That’s it for now, but honestly, there are a lot more similarities and differences, but we think the above are enough to give you a general sense between the two.
Approaches to Sectorial Stock Investing
The top-down approach involves identifying promising sectors first and then selecting individual stocks within those sectors based on various criteria such as growth potential, valuation, and market share.
The bottom-up approach focuses on individual stock analysis. Investors select companies they believe have strong growth prospects and then assess the industry’s potential based on the chosen stocks.
The combination approach merges both top-down and bottom-up analysis to make informed sectorial investment decisions.
Which one is better?
You’d probably guess this answer — depending on your preference. I mean, what do you want us to say? Go buy funds? What if you can’t afford the fees? Or you can, but it’s not simply within your plan. They both have their pros and cons and here’s the thing — sometimes your pros are others’ cons. Take actively managed, as an example. Some people like to take the risk for the chance of benchmark-beating gains, while others would just like to hug on indices and slowly go up as the indices grow.
Know what you want from it, then you’ll know what to go for, that’s the only thing we can advise you with when it comes to making these choices.
In conclusion, funds and exchange-traded funds (ETFs) share similarities as investment vehicles, but there are significant differences in their structures and functionalities. Both funds and ETFs offer investors the opportunity to pool their money and benefit from professional management and diversification.
They both incur fees, provide access to various investment themes, and allow investors to benefit from dividends and capital gains. However, the manner in which they are bought and sold differs greatly. Funds are purchased directly from the fund provider and execute trades at the end of the trading day, while ETFs are traded on stock exchanges throughout the trading day.
Additionally, funds tend to have more complex fee structures, while ETFs often have less complex fee structures. Taxation rules also vary between the two, affecting capital gains and dividends differently. The decision between funds and ETFs ultimately depends on individual preferences, risk tolerance, and investment objectives. Each has its advantages and disadvantages, and investors should carefully consider their financial goals to make an informed choice between the two.
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None of the material above or on our website is to be construed as a solicitation, recommendation or offer to buy or sell any security, financial product or instrument. Investors should carefully consider if the security and/or product is suitable for them in view of their entire investment portfolio. All investing involves risks, including the possible loss of money invested, and past performance does not guarantee future performance.