Ask a Fool: What's the Difference Between an ETF and a Mutual Fund?

By Matthew Frankel Markets Fool.com

Q: What's the difference between an ETF and a mutual fund?

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Exchange-traded funds (ETFs) and mutual funds have a lot in common. Both are pools of investors' money that are used to invest in an assortment of stocks, bonds, or other assets, in order to diversify risk and take the guesswork out of investing. Both of these investment vehicles are designed to simplify investing, as they have managers who monitor the fund's investments and adjust them when necessary.

The biggest difference between ETFs and mutual funds is how they are bought and sold by investors.

ETFs trade just like stocks, in the sense that they are listed on major exchanges such as the NYSE, and their shares fluctuate in price throughout the day. On the other hand, mutual funds are priced only once each day -- at the end of the day, the fund's net asset value is calculated and is divided by the number of outstanding shares. In other words, ETFs are priced based on the instantaneous supply and demand for each fund's shares, while mutual funds are priced on the actual value of the fund's assets at the end of the day.

There are a few other differences, such as the requirement of mutual funds to distribute most of their capital gains each year (ETFs have no such requirement). And while both types can be either passively or actively managed, most ETFs are passively managed index funds. Also, mutual funds tend to have minimum investment requirements of $1,000 or more, while an ETF investor can purchase as little as one share at a time.

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