Before you begin executing your sector investing strategy, it's important to understand the differences between how mutual funds, exchange-traded funds (ETFs), and stocks trade. The table below summarizes the topics reviewed in this article. Read on to learn more.
Basics of mutual fund trading
Mutual funds are professionally managed portfolios that pool money from multiple investors to buy shares of stocks, bonds, or other securities. Most mutual funds require a minimum initial investment, although there is an increasing proliferation of no minimum required investment funds.
When you buy or redeem a mutual fund, you are transacting directly with the fund, whereas with ETFs and stocks, you are trading on the secondary market. Unlike stocks and ETFs, mutual funds trade only once per day, after the markets close at 4 p.m. ET. If you enter a trade to buy or sell shares of a mutual fund, your trade will be executed at the next available net asset value, which is calculated after the market closes and typically posted by 6 p.m. ET. This price may be higher or lower than the previous day's closing NAV.
Some equity and bond funds settle on the next business day, while other funds may take up to 3 business days to settle. If you exchange shares of one fund for another fund within the same fund family, the trade will usually settle on the next business day.
Mutual fund sales charges and fees
Mutual fund trades may be subject to a variety of charges and fees. Some funds carry a sales charge or load, which are fees you pay to buy or sell shares in the fund, similar to paying a commission on a stock trade. These can be in the form of upfront payments (front-end load) or fees you pay when you sell shares (contingent deferred sales charge).
In addition to loads, you need to know what, if any, fees may apply to the funds you are trading. These may include:
- Short-term redemption fees: Some, but not all, funds charge short-term redemption fees to defray costs associated with short-term trading of a fund's shares. These fees typically range from 0.5% to 2% of your trade and are usually assessed on shares held for periods ranging from less than 30 days to less than 180 days, depending on the fund.
- Short-term trading fees: You may be subject to a short-term trading fee if you sell or exchange shares of certain non-transaction fee funds within 60 days of purchase.
- Transaction fees: Transaction fees are similar to the brokerage commission you pay when you buy or sell a stock. For some no-load funds, you will be charged a transaction fee on purchases, but not on sales. The amount charged will depend on whether you trade online ($75) or through a representative ($100 minimum, $250 maximum).
- Purchase fees: This fee differs from a front-end sales load because the fee is paid to the fund, not to a broker, and is typically imposed to defray some of the fund's costs associated with the purchase.
- Exchange fees: Some funds charge a fee when you exchange (transfer) to another fund within the same fund family.
- Account fees: Some funds charge a separate account fee to cover expenses related to maintaining their accounts. These fees are typically imposed on accounts when the dollar value falls below a certain threshold.
Trading ETFs and stocks
Exchange-traded funds (ETFs) and stocks may be more suitable for investors who plan to trade more actively, rather than buying and holding for the long term. ETFs are structured like mutual funds, in that they hold a basket of individual securities. Like index funds, passively managed ETFs seek to track the performance of a benchmark index, while actively managed ETFs seek to outperform a benchmark index.
There are no restrictions on how often you can buy and sell stocks or ETFs. You can invest as little as $1 with fractional shares, there is no minimum investment and you can execute trades throughout the day, rather than waiting for the NAV to be calculated at the end of the trading day.
Unlike mutual funds, prices for ETFs and stocks fluctuate continuously throughout the day. These prices are displayed as the bid (the price someone is willing to pay for your shares) and the ask (the price at which someone is willing to sell you shares). So while ETFs and stocks have bid-ask spreads, mutual funds do not. It's also important to note that ETFs may trade at a premium or discount to the net asset value of the underlying assets.
Order types and commissions for ETFs and stocks
As stated earlier, ETFs, like stocks, are trading on the secondary market. When buying or selling ETFs and stocks, you can use a variety of order types, including market orders (an order to buy or sell at the next available price) or limit orders (an order to buy or sell shares at a maximum or minimum price you set). You can place stop loss orders and stop limit orders, as well as "immediate or cancel," "fill or kill," "all or none," "good 'til canceled," and several other types of orders. You can also execute short sales.
ETFs and stocks do not carry sales charges, but you will be charged a commission each time you execute a trade online (unless the ETF is part of a commission-free online trading program).
Trading for stocks and ETFs closes at 4 p.m. ET, but unlike with mutual funds, you can continue trading stocks and ETFs in the after-hours market. However , only the most experienced traders may want to consider after-hours trading, as the difference between the price at which you sell (the bid) and the price at which you buy (the ask), tends to be wider after hours and there are fewer shares traded.