Physicians - ETFs Vs. Mutual Funds

For physicians embarking on their investment journey, understanding the distinction between two popular investment vehicles, mutual funds and exchange-traded funds (ETFs), is crucial. While both are commonly available within investment plans, it is essential to understand the unique advantages of each.

Mutual funds and ETFs are both pooled investment securities that can be traded similarly to individual stocks. A mutual fund may consist of stocks, bonds, or a combination of both. ETFs are essentially funds traded on stock market exchanges, typically mirroring market indices. Both pool funds from numerous investors while providing a great diversification source. However, it's vital to grasp the characteristics that make each stand out.

The most significant difference lies in the ability to buy and sell: ETFs can be traded throughout the day, similar to how an individual stock trades, whereas mutual funds can only be bought at market close after prices are set each day. Additionally, mutual funds are bought and sold directly through the mutual fund sponsor or brokerage firms, making automatic investing convenient. ETFs are typically passively managed, meaning investments are selected based on the index a fund tracks. In contrast, mutual funds are more often actively managed by a team of professionals who curate a mix of investments for the fund. As of recent there has been an emergence of more actively managed ETFs.

It is important to understand the difference in expenses. Both mutual funds & ETFs have costs associated with investing in them, referred to as the expense ratio. Traditionally the expense ratio for mutual funds is higher than for exchange traded funds, however that is not always the case. Furthermore, actively managed funds tend to have a higher expense ratio than passively managed funds. Whether seeking the flexibility of an ETF or the stability of a mutual fund, physicians have the option to invest in both.

Understanding the difference in tax efficiency when comparing a mutual fund to an ETF is another important factor to consider. Generally, ETFs tend to be more tax efficient than mutual funds. In a mutual fund the manager must frequently rebalance the securities for shareholder redemptions or to reposition assets. Rebalancing the securities within the mutual fund can inadvertently create capital gains for the shareholders – even in years when you have unrealized or realized losses. Alternatively, there are two main reasons why ETFs tend to be more tax efficient; first, they are usually passively managed, meaning there is not a frequent change in the holdings of that ETF. Second, structurally ETFs are different, instead of selling securities from the fund, ETFs allow for in-kind transactions which gives the shareholder more control of capital gains. To summarize, ETFs tend to provide more tax efficiency than mutual funds. Keep in mind tax efficiency is more of a consideration in non-retirement accounts than in retirement accounts.

Despite investing being a primary focus for many physicians, the vehicle for accomplishing the investment is often glossed over. Mutual funds and ETFs offer opportunities to pool investments and pursue market returns. These investment vehicles can serve as pathways to achieve the financial freedom physicians deserve.