Mutual Funds vs. ETF’s

Both mutual funds and exchange traded funds (ETF’s) are investments in which shareholders pool their money with the intent of investing in diversified portfolios of securities.

These securities can be stocks, bonds, real estate, or almost anything that represents financial value.  Instead of having to research and choose specific investments, they are chosen and managed by a professional manager.

Mutual Funds

When you invest in a mutual fund you own a piece of the fund in the form of units.  When the value of the underlying investments rises and falls, so does the value of your fund units.

Mutual funds can only be bought and sold at the end of the trading day so the price might be different from what you see when you make your trade.  They can be purchased for as little as $25 with a regular purchase plan (weekly, biweekly, monthly, etc.), which is an advantage for small portfolios and beginning investors.  Most funds have no cost to purchase.

Because a professional team manages mutual funds, they often have high expense ratios (MER’s).  Money market, bond and index funds generally have lower MER’s and actively managed growth funds, foreign and sector funds can have fees in excess of 3%.

Mutual funds can be an easy way to have a diversified portfolio, but make sure it truly is diversified.  With Canada’s relatively small market there may be a redundancy of holdings because the fund managers all picked stocks from the limited list on the TSX.  Take a look at each of the funds largest holdings to see where there may be redundancies.

ETF

Exchange traded funds (ETF’s) are a group of funds that are traded daily on the stock market just like individual equities.  That makes them more flexible than mutual funds because you can buy and sell shares throughout the day and the price is constantly updated.

They typically offer a passive approach to investing in either an entire stock market index or one of many sub-indexes.

ETF fees are often lower than mutual funds fees because most ETF’s don’t need to be actively managed.  An average MER is about 0.5%.  However, since any trade is subject to the broker’s trading fees (up to $29 per trade) ETF’s are not suitable to small regular purchase plans as the trade fee will quickly outweigh any reduction in MER’s.

The range of ETF investments have grown quickly with iShares being the most prolific creator and marketer.  Some of the most popular ETF’s have been leveraged and inverse leveraged to magnify gains.  This type of ETF is designed to track the daily return of the underlying index.  At the close of each trading day the fund is reset for the next day.

An inverse ETF gains value as the market goes down because it is structured to make money when stocks decline.  Care must be taken to understand the risks unique to this form of investing.  Under certain conditions they can perform substantially below expectations and are definitely not to be used for a buy-and-hold strategy.

Both mutual funds and ETF’s offer indirect methods of investing using the same long-term focus of balance and diversification without having to select investments directly.

Do you own either one?  When you compare an ETF vs Mutual Fund, which type do you prefer?


8 Responses to Mutual Funds vs. ETF’s

  1. I have mostly mutual funds and stocks, but I also have two ETFs (SPY & QQQ). My focus is performance and diversification. I like the lower fees, but it is very volatile right now.

  2. I don’t invest in either ETFs or Mutual Funds, but I am looking to start possibly in the later part of this year. ETFs I think will be my choice, due to lower MERs.

    I was thinking with INGs Street Wise Fund? Any thoughts?

    BTW great post for newbies like me :)

    • @Eddie: Thanks for your comments. ING’s Street Wise Funds are 3 balanced index mutual funds – balanced, income & growth that aim to match the returns of various major benchmarks. MER is 1%.
      I think it’s a good mutual fund for beginning investors especially if you want to enroll in a regular purchase plan.

  3. I like ETF because it’s easier to trade. I only buy no load mutual funds and I always had to pay a transaction fee to the broker. I think this is better than a load fund though.

  4. I have a web site where I give advise on penny stocks and stocks under five dollars. I have many years of experience with these type of stocks. If their is anyone that is interested in these type of stocks you can check out my web site by just clicking my name. I would like to comment about index funds. The question that I have for investors is this their are now hundreds of exchange traded funds and closed end fund available to investors. Why would any investor buy a broad based index fund like the standard & poors 500 index when you can pick from dozens of single country funds some of which are down by 80% from their highs of a few years ago or exchange traded funds that are concentrated in a very narrow sector like uranium maritime shipping that may be great bargains in the future. Anyone of which could be a spectacular bargain at some point in time that is if one is patient enough some of these single country funds and narrow sector focused funds will become spectacular bargains. Why buy a broad based index fund and get a mediocre return when say the first ireland fund is down by almost 75 percent from its high of two or three years ago a great buying opportunity. This is just one example. simply put if one can buy a diversified porfolio of narrow sector funds and single country funds when they are down by 70 80 or even 90 percent from their highs why bother with broadly diversified index funds.

    • @james moylan: Many people don’t have the time or expertise to research these type of investments themselves and that’s one reason why index funds and ETFs are so popular.

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