The difference exchange-traded funds and other types of funds

• ETF stands for Exchange Traded Fund.
• EFTs do not have any holding periods and can be freely exchanged from the moment the exchange opens.
• EFTs are bound to a specific index.
• EFTs tend to cost little, their Total Expensive Ration (TER) commonly ranges between 0.2%-0.5%.
• Mutual Funds have a fund manager
• In Germany, there is no difference in taxation.
• The biggest advantage of EFTs is the lower costs.

Since the financial crisis of 2008, ETFs have become popular among institutional and private investors with their combination of low costs, diverse options, and good yields. But there are still other options when it comes to funds! While EFTs is commonly used as a catch-all term, there are significant differences, making understanding EFTs vs. funds essential.

This article includes a concise introduction to this, enabling you to understand why EFTs are prominent and why other funds are available.

What Is An ETF Vs. Mutual Fund

ETF stands for Exchange Traded Fund. A fund is an investment vehicle collecting money from various investors to finance investments. The investments can vary from stocks, bonds, real estate, or something else.

ETF: Traded On The Exchange

The trading of funds can vary. In German, real estate funds, especially, force investors to commit to prolonged holding periods. While it is not uncommon for funds to have specified time limits or be limited to selling or buying shares on set dates, you need direct contact with the fund

Hence, the Exchange Traded is so important, allowing funds to be purchased and sold on the public exchange. EFTs do not have any holding periods and can be freely exchanged from the moment the exchange opens. Although, this feature isn’t exclusive to ETFs.

EFTs are investment vehicles that can be bought and sold on the exchange. However, there are many other characteristics.

ETF: Index And No Manager

EFTs are bound to a specific index, the same as Stock-EFTs and Bond-EFTs. The importance of the index is to form criteria that determine if assets can be included. Commonly this can be by industry or country but can vary to dividend payments or ESG ratings The best-known indices are the S&P 500, the Dow Jones, and the DAX. Changing the composition of an index is rare, resulting in EFTs having little leeway to adjust the investment. But this is not a disadvantage!

Where other funds have a paid dedicated fund manager, this incurs higher fees which can be higher than 2% of the invested sum. While “passive managed” EFTs tend to cost 1% or under, their Total Expensive Ration (TER) commonly ranges between 0.2%-0.5%.

Plus, most actively managed funds fail to beat EFTs in performance, with the investing paying higher costs for lower returns.

ETFs Vs. Mutual Fund

Comparisons of ETFs vs. Mutual Funds are commonly made. EFT-Proponents portray them as directly opposing concepts, but this isn’t true. EFTs are more of a subcategory of mutual funds.

Their special characteristics, passive management, index-based, and Exchange Traded, all define ETFs but are not exclusive. Plenty of mutual funds follow an index-based approach and can be traded easily on the exchange.

Therefore, when setting up a new fund as an EFT or a mutual fund, the decision is based primarily on branding and pricing rather than underlying mechanics or regulations. Commonly, mutual funds incur higher fees and are more interesting for the underlying company.

ETFs Vs. Index Fund

There is one big difference between EFTs and other Index Funds, which impacts traders. While both can be traded on the exchange, the pricing variations are vast!

EFTs behave similarly to stocks, with fluctuations in price throughout the day depending on supply and demand. Making it possible for a buyer to spend less one hour before and sell, making profits minutes later.

In contrast, index funds have their portfolios evaluated daily before each trading day, and each share’s worth is set for that day, resulting in the shares costing the same for the whole day.

This difference is unimportant for those investing more extended periods but essential for those wanting to day-trade. Not only does it limit the intraday trade to ETFs, but it also provides an indicator for margin trading.

ETFs Vs. Mutual Fund Tax

The differences in taxation are frequently discussed when looking at EFTs vs. mutual funds. However, taxation varies significantly, and a single answer to this topic is not possible. Taxation depends on many factors, including your residence and even citizenship, and what applies in one country may not in another.

In Germany, there is no difference in taxation. Under normal circumstances, ETFs and mutual funds are taxed with the “Abgeltungssteuer” of 25% on profits and dividends, not including payment retained in the fund for reinvestment. With no benefits offered in Germany for accumulating (ACC) or distributing (DIS) funds.

If you choose, you can include your gains in your tax report. Then the authorities have to check if it is more beneficial to use your income tax or the “Abgeltungssteuer.”

Advantages Of ETFs Over Mutual Funds

So, what is it that makes ETF so popular? The Truth is simple. Most differences are unimportant for the average investor. Intraday tradability on benefits day traders and short-term buyers. There are no tax benefits or performance differences.

The biggest advantage of EFTs is the lower costs. Investors get the inherent benefits of a fund, diversification, and market coverage without large fees. This is highly beneficial for long-term investors relying on reinvesting profits to achieve exponential growth, between 0.4% and 2% per year.

An example: if an investor has €10000 and a 20-year timeframe, they can choose between an EFT with 0.4% TER or a mutual fund at 2%. Both options have the same performance of 5% per year. After 20 years, the mutual fund with be around €18000, with the EFT at about €24500. A surplus of €6500! But with the cheaper ETF, he will gain around €24500. A surplus of €6500!

This difference is not some grand secret or complicated subject, yet of exponential influence, resulting in cheaper ETFs and better investments.