Which is the Best Way to Diversify Your Portfolio: Mutual Funds or ETFs?

Your stockbroker may have recently suggested diversifying your investment portfolio by investing in either mutual funds or Exchange-traded funds (ETFs).  But, you are great investor and want to be completely familiar with an investment vehicle prior to investing.  In many ways mutual funds and ETFs are similar, but differences will help you decide on what is best for your personal investment strategy.

Overall, the expenses and fees of an ETF are lower than a mutual fund and ETFs offer some tax advantages because they are passively managed investment choices.  However, ETFs typically have smaller capital gains than an actively managed mutual fund.

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For mutual funds there are two different types of legal structures that it can fall into.

  1. Closed-Ended FundsThese types of mutual funds release only a specific number of shares and will not issue new shares as popularity of the fund grows or current investors demand it. Prices for these types of mutual funds are determined by the demand from the investors for the shares of the fund.
  2. Open-Ended FundsThese funds are the most popular type of mutual fund available. There is not a limit placed on the number of shares that are issued and as investor demand rises so does the number of shares.  The price of a share in this type of mutual fund is dependent on the market valuation.

For ETFs, there are typically three different legal structures.

  1. Exchange-traded Grantor TrustsThis type of ETF can be confused with a closed-end fund, however the biggest difference is that the investor in the ETF reserves voting rights with the companies that are in the ETF, because the investor still holds legal ownership of the shares. Investors must trade in 100-share increments and dividends from the stocks cannot be reinvested.
  2. Exchanged-traded Unit Investment Trust (UIT)UITs have to achieve a fine balance between replicating their index and, also falling under the Investment Company Act of 1940. They are limited to investing in a single issue to 25 percent or less.  UITs cannot have reinvested dividends but do provide cash dividends quarterly.
  3. Exchange-traded Open-End Index Mutual Fund

Again, this fund falls under the Investment Company Act of 1940, however it is essentially a mutual fund that is made up of ETFs.  This type of fund may be considered the best of both worlds, however it is always in your best interest to read and possibly discuss all of the legal documents associated with an investment.  Dividends for this investment are reinvested on the day that they are received from their specific companies and paid to investors in cash every quarter.

As an investor it is up to you to make the correct decision that is best for your portfolio and seek counsel if needed.  Should you ever feel that the counsel which was provided to you as an unsuitable recommendation then reach out to a investment law professionals such as Thomas Law Group at www.thomaslawgroup.net to discuss the specifics of your situation and determine if you have a case.

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