In Singapore, mutual funds are gaining popularity because of their low entry price and diversification. But even though ETFs overlap a lot with a mutual fund, many people still do not understand how they work. This article aims to clarify some misconceptions about ETFs and compare them with mutual funds.
What is an Exchange Traded Fund?
An exchange-traded fund (ETF) is a marketable security that tracks the performance of an index, commodity or bond. It trades on exchanges just like stocks but can be bought or sold throughout the day at market prices. Since ETFs have lower fees than most actively managed funds, it becomes desirable for investors who prefer low-cost products.
Even so, there are a few things that investors should be wary of when investing in ETFs. Firstly, since most broad-market ETFs track indexes and not specific companies, they can sometimes yield different results than the index they are trying to track. Secondly, some novice traders might get tempted into shorting ETFs, but this is a risky activity that requires more knowledge about how they work.
What is an Index Fund?
The index fund is a mutual or unit trust that seeks to replicate an existing market index. It has lower fees than funds that try to beat the market indices by actively researching and trading securities. The S&P 500 Index tracks about 80% of the United States stock market while other indices aim for global markets like emerging markets, frontier markets, etc.
Investing in an index fund is a long-term commitment because it tends to track market indices over time rather than beat the market. Investors can buy into an ETF in Singapore that tracks the Sprott Physical Gold Trust. The SPDR S&P 500 ETF Trust, on the other hand, tracks American companies listed on the New York Stock Exchange.
What are some key differences between ETFs and Mutual Funds?
The first significant difference between these two financial instruments is price. An exchange-traded fund is simply a basket of securities that directly correlates with its net asset value (NAV). To calculate NAV, you would have to divide total assets minus liabilities by the number of shares outstanding. In this way, ETFs are more transparent and more manageable for investors to track their performance. However, a mutual fund is priced at the end of each trading day. It allows fund managers to use market prices instead of NAV to determine their net asset value.
Mutual funds also have higher fees because they require active management, whereas an ETF tracks established indices or commodities. It means that you need skilled traders who make educated guesses on where markets are heading for mutual funds to outperform their benchmark indices.
What are some key similarities between ETFs and Mutual Funds?
For one, mutual funds and exchange-traded funds require a specific entry point, which means you cannot ‘buy in’ at any given price. Instead, you must buy into an open-end fund by purchasing its units or shares at NAV. According to prevailing prices on exchanges, this purchase gets ‘marked to market’ (valued) every day.
Secondly, they can be bought through retail and professional brokers who charge their services (check over here). In addition, each financial institution has its policies regarding minimum initial investments and trading costs.
What are some key benefits of ETFs over Mutual Funds?
ETFs have several advantages over open-ended mutual funds, which include:
- The lower fees are due to lower management expenses for maintaining a portfolio. Unlike a mutual fund, an ETF does not require active traders to make educated guesses based on market research and analysis.
- Transparency in pricing directly correlates with its net asset value (NAV). This way, it is much easier for investors to track their performance than mutual funds, which use end-of-day prices that can sometimes deviate from NAV.
- Security because each ETF has a custodian bank that holds underlying assets for the fund. It ensures that every investor gets paid even if something happens to the fund provider. If you compare this with hedge funds, there is no recourse if investments go sour.