Jun 5, 2023
ETFs vs. Mutual Funds: Which Is Right for You?
ETFs (exchange traded funds) and mutual funds are both investment vehicles that pool stocks, bonds, or other securities into a single fund. While they share many similarities, there are a few key differences investors should understand when considering buying shares. Either type of fund could help you diversify your portfolio, but one or the other may be more suited to your individual needs and preferences. Important differences include the way each fund is managed, their respective fees, when you can buy or sell your assets, and more.
|Exchange traded fund (ETF)||Mutual fund|
|Usually passively managed||Usually actively managed|
|Usually have lower fees||Usually have higher fees|
|Actively trade throughout the trading day||Trades close at the end of the trading day|
|Share prices fluctuate throughout the trading day||Share prices are calculated at the end of the trading day|
In this article, we’ll cover:
- Similarities between ETFs and mutual funds
- Differences between ETFs and mutual funds
- Choosing the right fund for you
Similarities between ETFs and mutual funds
You can think of any fund, whether an ETF or mutual fund, as a basket of securities. When you buy shares of a fund, you’re investing in all of the assets it holds. The fundamental ways in which ETFs and mutual funds work is quite similar:
- Diversification: Each type of investment vehicle holds a collection of different securities or asset classes, which can be an efficient way to add diversity to your portfolio.
- Fees: Both ETFs and mutual funds have some fees associated with them, such as transaction or management fees.
- Investing strategy: Every fund has a particular strategy that guides the investments it holds. You can choose funds associated with industry sectors, geographic regions, investment approaches, and more.
- Liquidity: Both ETFs and mutual funds are generally quite liquid, meaning you can sell your shares for cash relatively quickly
- Risk: All investment comes with risk, including the risk that you could lose money. ETFs and mutual funds are no different, and the risks vary depending on each individual fund.
Differences between an ETF and a mutual fund
On the surface, ETFs and mutual funds seem very much the same. But understanding the key differences can help you make the appropriate investment decision for you. Mutual funds and ETFs differ in terms of their trading flexibility, minimum investing requirement, management style, costs and fees, and tax efficiency.
|Differences||Exchange-traded funds (ETFS)||Mutual funds|
|Trading flexibility||Can be traded throughout the trading day||Trades close at the end of the trading day|
|Minimum investing requirement||Not required beyond the price of a single share||Required; amount depends on the fund|
|Management||Passively managed||Actively managed|
|Cost and fees||Lower costs and fees||Higher costs and fees|
|Tax efficiency||Lower tax implications||Higher tax implications|
ETFs can be bought and sold on an exchange, just like individual stocks. That means their prices fluctuate throughout the trading day along with the market. On the other hand, mutual fund prices are calculated at the end of each trading day. This calculation, known as the net asset value, or NAV, is the per-share value of a mutual fund’s assets minus its liabilities. Instead of purchasing mutual funds on an exchange, investors buy and sell mutual fund shares directly from the fund or from a brokerage that sells the fund.
Minimum investing requirement
In general, mutual funds require a minimum investment amount. Minimums will vary depending on the specific fund, but they can be several thousand dollars. Many funds allow the purchase of fractional shares, meaning you can purchase just a portion of a share instead of a whole one, you’ll generally still have to invest the minimum required amount of money. In contrast, ETFs can be purchased as single shares, so there is no minimum required beyond the cost of a single share. Fractional shares are usually available as well.
Mutual funds tend to be associated with an active management style that involves frequent buying and selling to outperform a specific benchmark or index. An actively managed mutual fund typically has a portfolio manager and other team members who use their expertise to make ongoing decisions about the fund. ETFs, in contrast, are usually associated with a passive management strategy that does not require a decision-making team because the fund is built to track an index like the S&P 500 or the Dow Jones Industrial Average.
Cost and fees
Mutual funds tend to have higher management fees because they are actively managed by portfolio professionals. They’re also likely to have higher transaction fees due to the frequency of trading. ETFs generally have lower expense ratios than mutual funds. Many ETFs trade for free, though some may require a commission. Transaction fees are typically lower for ETFs, and they don’t carry sales load or redemption fees like mutual funds.
Generally speaking, the overall operations of an ETF are more tax-efficient than mutual funds. Due to the way ETFs are structured, they often sell shares in a manner that triggers fewer taxable events. Mutual funds pay investors capital gains distributions, so their tax implications tend to be higher.
Choosing the right investment fund for you
There is no “one size fits all” answer to investing. Choosing the type of investment fund that’s right for you takes careful consideration. Take the time to assess your investment goals, risk tolerance, and preferences about how involved you want to be in the day-to-day management of your investments.
- Investment goals: Knowing whether your investment goals are long-term, like saving for retirement, or shorter-term, like saving for a home purchase, will help you determine the type of investments that make the most sense for you.
- Risk tolerance: Reflect on the level of risk you’re comfortable with. Are you a conservative investor who prefers more stability, even if that leads to lower returns? Or are you comfortable with a more aggressive investing style that takes on more risk of volatility in the hopes of higher returns?
- Level of involvement: Are you more of a hands-on investor or a “set it and forget it” investor? Actively managed funds, like mutual funds, take more effort and direct involvement than passively managed funds, like most ETFs.
Additionally, it’s important to evaluate the fees, expenses, and performance history associated with any particular fund. Mutual funds and ETFs will each have a prospectus that outlines investment objectives, risks, fees, expenses, and other information that you should read and consider carefully before investing.
- Fees and expenses: A fund’s fees and expenses can add up quickly. Consider the benefits and drawbacks of every expense that may come along with choosing an investment fund. Remember that while ETFs tend to have lower fees than mutual funds, every fund is unique, so check on the fees for every fund you’re considering.
- Fund performance and history: Historical data can show you how a fund has performed over time, how well portfolio managers have handled previous ups and downs, and offer some insight into how the fund may perform in the future.
ETFs vs. mutual funds: the bottom line
If you’re looking to diversify your portfolio, both ETFs and mutual funds may be investments worth considering. When you’re getting started as an investor, a fund may provide an accessible entry point, giving you access to a variety of securities with a single investment. And you don’t necessarily have to choose between ETFs vs. mutual funds; you may decide that both have a place in your investing strategy. You can invest in a wide variety of ETFs with Stash, and thanks to fractional shares, you can get started with any dollar amount.
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