ETFs vs. mutual funds: What’s the difference?
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ETFs and mutual funds are both stable forms of investment suited for long-term investors. You can invest in either to diversify your portfolio and hedge against specific-stock risks in the long run. This page outlines the key similarities and differences of both financial investments to help you evaluate the better fit for your portfolio.
What is an ETF?
Copy link to sectionAn ETF is a bundle of investment securities (i.e. stocks and bonds). Depending on the type and sector of the ETF in question, they typically track the performance and yield of a specific index, industry, commodity, or other assets. If you are interested in intraday trading, you will be happy to learn that you can buy and sell shares of ETFs throughout the trading day.
Like individual stocks, you can buy or sell shares in an ETF on the stock market at your convenience. Consequently, ETF prices fluctuate throughout the trading day as they are bought and sold on the market. The majority of ETFs are passively managed though in recent years, there has been a small rise in actively managed ETFs on the market.
What is a mutual fund?
Copy link to sectionA mutual fund is a bundle of securities (i.e. stocks and bonds) that is pooled together using money from investors. Mutual funds are actively managed and you cannot intraday trade a mutual fund. You can only buy and sell shares in a mutual fund at a set price at the end of a trading day.
Mutual funds are managed by fund managers or teams that make investment decisions to buy and sell securities within the fund. The management team tries to beat the market with their investment strategy with the hope of enabling profits for investors. This manpower often means that it is more expensive to invest in a mutual fund than in an ETF.
What’s the difference between ETFs and mutual funds?
Copy link to sectionETFs and mutual funds are more alike than they are different, but their distinct nuances set them apart for investors. To bolster your knowledge, we have detailed some of the key differences between ETFs and mutual funds below.
- Methods of buying and selling. How you buy and sell an ETF as opposed to a mutual fund is the crucial difference between the two. ETFs, like stocks, can be traded throughout the day. Whereas mutual funds can only be purchased or sold for the set price at the end of the trading day.
- Pricing. The shares of ETFs are priced according to market forces. In contrast, mutual funds are priced according to their net asset value at the end of each trading day.
- Management strategy. ETFs are predominantly passively managed investments though recent years have noted a proportion of actively managed ETFs on the market. Whereas mutual funds are entirely actively managed investments, they require manpower that is reflected in their fees.
- Fees. There are low costs of investing in ETFs as the majority are passively managed bundles of securities and therefore they have lower expense ratios. On the other hand, there are much higher costs to investing in actively managed mutual funds as they have higher expense ratios that reflect management fees.
- Changing brokers. ETF shares can easily be transferred from one broker to another, whereas you would have to close your position in your mutual fund in order to change brokers.
- Tax efficiency. ETFs are normally more tax efficient than mutual funds. As ETF shares are traded on exchanges, Capital Gains tax implications are lower as there is a buyer for every seller. By contrast, since mutual fund shares are redeemed within the mutual fund company when sold, there are higher Capital Gains tax liabilities.
Similarities between ETFs and mutual funds
Copy link to sectionDespite their nuanced differences, ETFs and mutual funds have a lot in common. To expand your knowledge, we have highlighted some of the key similarities between the two investment vehicles below.
- Diversification. ETFs and mutual funds offer you the benefit of portfolio diversification through broad and wide-ranging exposure to the market. For example, an ETF that tracks the performance of the S&P 500 gives you access to some of the world’s largest companies through a single share purchase.
- Long-term returns. Historically, bundled pools of securities have always beaten the market in the long run. As both ETFs and mutual funds hedge against specific-security risk, you are poised for steady long-term returns.
Which one is right for me?
Copy link to sectionYou should buy an ETF if you are seeking a tax-efficient, low-cost exposure to the market. ETFs are also the better option for you if you are interested in intraday trading your ETF shares as you would your stocks.
Whereas you should invest in a mutual fund if you value active management as a strategy to beat the market. You must also have a budget that allows for higher fees and (usually) a higher minimum initial investment than there is for ETFs.
The best places to invest
Copy link to sectionIf you are ready to take the dive and invest in either an ETF or a mutual fund, the best way to do so is through the best selected ETF platforms, and requires you to register and set up an account with an online broker. Click through the links below for our selection of the top brokers in the market today.
77% of retail CFD accounts lose money.
A quick recap
Copy link to sectionWhether you invest in ETFs or mutual funds depends on your particular investment strategy and your portfolio goals. ETFs and mutual funds are both bundles of securities that provide broad exposure to the market and diversity for your portfolio. Both investment vehicles are suitable for long-term investors and you should do your due diligence to best place your investment.
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