Mutual Funds vs. ETFs: Which Is The Right Choice For You?
When exploring investment options, mutual funds and exchange-traded funds (ETFs) are two popular choices. Though they serve similar purposes, they operate differently, and understanding these differences is essential for making informed investment decisions.
How Mutual Funds Work
Mutual Funds combine capital from multiple investors to purchase a diversified portfolio of assets such as stocks, bonds, or other securities. Investors buy shares in the mutual fund itself, not directly in the underlying assets.
Key Characteristics:
Management Style: Mutual funds can be actively or passively managed. Actively managed funds have professional managers who make investment decisions they feel will outperform the market. Passively managed funds aim to mirror the performance of a specific index, like the S&P 500.
Net Asset Value (NAV): The price of mutual fund shares is determined at the end of each trading day. The NAV is calculated by dividing the total value of the fund’s assets by the number of outstanding shares.
Minimum Investment: Many mutual funds have a minimum investment requirement, which can range from a few hundred to several thousand dollars.
Fees: Mutual funds typically charge management fees expressed as an expense ratio. Actively managed funds usually have higher fees due to the cost of research and management. Some funds also have sales charges.
How ETFs Work
Exchange-Traded Funds (ETFs) pool money from multiple investors to acquire a diversified portfolio of assets but trade on stock exchanges like individual stocks.
Key Characteristics:
Trading: ETFs are bought and sold throughout the trading day at market prices, which can fluctuate. This intraday trading allows for greater flexibility in buying and selling compared to mutual funds.
Management Style: Like mutual funds, ETFs can be actively or passively managed. Most ETFs are passively managed and aim to track the performance of an index.
Minimum Investment: ETFs generally do not have minimum investment requirements other than the price of one share, making them more accessible for investors with smaller amounts.
Fees: ETFs usually have lower expense ratios compared to mutual funds, particularly if they are passively managed. While ETFs do not have sales loads, trading commissions may apply depending on the brokerage.
Comparing Mutual Funds and ETFs
Mutual funds and ETFs offer different features that cater to various investor needs. There are multiple factors that may influence which option is best for you.
ETFs generally offer lower fees, passive or active management, and more control over trading. If you’re working with an advisor, they also generally require more paperwork, signatures and prompt responses on your behalf. You also cannot purchase partial units of an ETF which makes it more difficult to implement a plan with periodic contributions.
Mutual funds generally have higher fees and less control over trading as you purchase or sell at whatever the price is end of day. The paperwork from an advisor is usually much less and partial units can be purchased.
If you prefer:
Having a professional manage the investment holdings closely,
Want to hold for the long term
Want to minimize what is required of you when making a transaction
Want to run a periodic contribution like $200/month
And are not overly concerned about slightly higher fees
Then investing in mutual funds may be right for you.
If you prefer:
Lower fees
More customization of individual holdings
Prefer to track an index passively
And you don’t mind some extra paperwork
Then investing in ETFs may be right for you.
There are thousands of options available for both mutual funds and ETFs. I work with both ETFs and mutual funds and can help you choose which option is best for you, as well as narrow down the specific funds or ETFs themselves. If you have any questions about these two tools contact me using the method that is best for you.