Which of the statements below is correct regarding the differences between exchange-traded funds (ETFs) and mutual funds?

Question

BlackTom AI · Accepted Answer

Here is the analysis of each option regarding how ETFs differ from mutual funds.
Option 1: 'ETFs are more liquid but provide higher costs than mutual funds.' While ETFs are often highly liquid and can trade at prices close to NAV, the claim that they have higher costs than mutual funds is generally inaccurate. In many cases, ETFs have lower expense ratios, and investors may benefit from lower ongoing costs. Also, the liquidity advantage is nuanced: some mutual funds (especially index funds) can be very liquid as well, and both vehicles can experience liquidity constraints under stressed market conditions. Overall, the statement mixes a potentially true liquidity angle with a typically false cost claim, making it misleading.
Option 2: 'ETFs provide lower costs but higher taxes than mutual funds.' This option correctly notes that ETFs tend to have lower ongoing costs due to structures like in-kind creation/redemption, but it incorrectly asserts higher taxes. In practice, ETFs are generally more tax-efficient than mutual funds because they minimize capital gains distributions through their liquidity mechanism. Therefore, the claim about higher taxes is not supported by typical ETF vs. mutual fund tax treatment.
Option 3: 'ETFs are more liquid and provide lower taxes than mutual funds.' This option aligns with common fund industry understanding: ETFs often offer intraday liquidity (trading throughout the day) and tend to be more tax-efficient due to the in-kind creation/redemption process, which reduces capital gain distributions compared to mutual funds. While there can be exceptions (e.g., market conditions affecting liquidity, or tax circumstances for specific holdings), this statement captures the predominant difference regarding liquidity and tax efficiency.
In sum, the first option blends a true liquidity point with a typically false cost claim, the second option correctly mentions costs but falsely claims higher taxes, and the third option correctly identifies both greater liquidity and lower taxes for ETFs relative to mutual funds.

BU.232.730.81.SU25 Final Exam

Which of the statements below is correct regarding the differences between exchange-traded funds (ETFs) and mutual funds?

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