An Exchange Traded Fund, also known as an ETF, is a fund whose shares trade on an exchange. To better understand an ETF, many investors like to compare it to a mutual fund.
Both an ETF and mutual fund are funds that own a portfolio of assets, such as stocks or bonds. So both an ETF and mutual fund offer investors the opportunity to invest in diversified portfolios.
To invest in these funds, investors can buy shares in the ETF or mutual fund. But how they buy and sell these shares is a major difference between an ETF and mutual fund.
ETF shares trade on a stock exchange similar to the way shares of individual companies trade. But mutual fund shares do not trade on a stock exchange. As a result, investors can trade ETF shares throughout the day. But investors can only trade mutual fund shares once a day, usually after the market closes.
Investors also trade ETF shares at the fund’s market price. And since the market price is affected by the portfolio asset prices and investor demand, both of which change during the day, investors may have the opportunity to trade at different prices throughout the day. However, investors trade mutual fund shares at the fund’s Net Asset Value or NAV. And since NAV reflects the closing prices of the portfolio assets, which is calculated only once a day, investors can only trade mutual fund shares at one price per day.
It’s important to know that an ETF’s market price is not always the same as the fund’s fair value or NAV. It can sometimes be higher and more expensive or lower and cheaper relative to its NAV. But the price of a mutual fund share is always at the fund’s fair value or NAV.
Remember, an ETF is a fund whose shares trade on an exchange. So it has the trading flexibility of a stock and diversification benefits of a mutual fund but greater price variability.