If you’re planning to start investing, you might be wondering whether you should put your money into mutual funds or exchange-traded funds (ETFs). Both offer access to stocks, bonds, commodities, and other asset classes, but they differ in a few ways.
To help you work out which type of product aligns best with your financial goals, we have put together this guide. Here’s a look at some of the key differences between mutual funds and ETFs.
What are mutual funds?
Mutual funds are investment products that provide diversified exposure to different asset classes. With these products, investors’ money is pooled together to form a larger amount of capital for investment. This capital is then managed by a professional fund manager or fund management firm, who will select investments for the fund on behalf of all the investors.
An example of a mutual fund is the Fidelity Blue Chip Growth Fund (FBGRX). This fund invests in US and international blue-chip companies with the aim of generating long-term capital growth for investors.
What are ETFs?
ETFs are quite similar to mutual funds. Like mutual funds, they are pooled investment vehicles that offer diversified exposure to different asset classes. A key feature of ETFs, however, is that they trade on the stock market (mutual funds don’t). This means that they can be bought and sold just like regular stocks.
It’s worth noting that there are both passive ETFs and actively-managed ETFs. The former aim to track indexes such as the S&P 500 and the Nasdaq 100 while the latter typically aim to beat the market.
An example of a passive ETF is the Vanguard S&P 500 ETF (VOO). This simply aims to track the S&P 500 index. An example of an actively-managed ETF is Cathie Wood’s ARK Innovation ETF (ARKK). This invests in a range of disruptive technology companies with the aim of generating high long-term returns.
How are ETFs similar to mutual funds?
From an investment perspective, ETFs and mutual funds have a lot of similarities. For a start, they both offer access to different asset classes (e.g. stocks, bonds, commodities, etc.). Secondly, they both allow investors to diversify their capital easily. Additionally, they are both subject to regulation designed to protect investors.
How are ETFs different from mutual funds?
The two main differences are in relation to how they are traded and their fees. With mutual funds, buy and sell orders are processed at the end of the day after the fund’s net asset value (NAV) is calculated. However, with ETFs, buy and sell orders go through immediately (when the market is open). This means that ETFs allow investors to be a bit more nimble when making trades because they can buy and sell the funds throughout the day.
As for fees, ETFs often have lower fees than mutual funds. For passive ETFs that track stock market indexes like the S&P 500, fees can be very low. The Vanguard S&P 500 ETF (VOO), for example, has annual operating expenses of just 0.03%.
Pros & cons of ETFs
Pros include:
- Exposure to different asset classes – with ETFs it’s easy to get exposure to different areas of the market.
- Diversification – with ETFs you can get exposure to hundreds or thousands of stocks through one product.
- Low costs – ETFs usually have very low fees.
- Nimbleness – ETFs allow investors to get in and out of positions throughout the day.
Cons include:
- Trading fees – some brokers charge trading fees to buy ETFs.
- Less control – with ETFs you don’t have a say in which companies your money is invested in.
- Price fluctuations – ETF prices can fluctuate a lot throughout the day.
Pros & cons of mutual funds
Pros include:
- Diversification – through one product you can get exposure to many different stocks.
- Professional expertise – with mutual funds, you benefit from the expertise of a professional fund manager.
- Low hassle – with these investment products, you don’t have to worry about picking individual stocks yourself.
Cons include:
- Fees – over time mutual fund fees can eat into your returns.
- Lack of transparency – mutual funds often do not disclose their full holdings.
- Less control – with mutual funds you don’t have a say in which companies your money is invested in.
- Delayed trades – orders are only processed at the end of the trading day.
What’s best – ETFs or mutual funds?
In terms of what’s best out of ETFs or mutual funds, this will depend on your investment goals and risk tolerance. Ultimately, there is no one-size-fits-all answer here.
ETFs might be the best choice for you if:
- You want to track a particular index such as the S&P 500 or the Nasdaq 100.
- Low costs are a priority.
- You want to be able to get in and out of positions throughout the day.
Whereas mutual funds might be the best choice for you if:
- You’re seeking the potential for higher returns through active management.
- You have a higher risk tolerance and are comfortable with returns that differ from market returns.
- You’re happy to wait until the end of the day to have your orders processed.
It’s worth pointing out that ETFs funds and mutual funds are not mutually exclusive investments. If you want to, you can combine both in an investment portfolio.
Need help investing?
If you’re looking for information on how to invest in ETFs or mutual funds, you can find some great tips in our guide on how to invest in mutual funds. This walks you through the steps involved in investing in mutual funds for the first time.
FAQs
Is the S&P 500 an ETF or a mutual fund? The S&P 500 is neither an ETF nor a mutual fund. Instead, it is a stock market index. However, there are both ETFs and mutual funds that track the performance of the S&P 500.
What is the average return on ETFs? It’s hard to say what the average return on ETFs is because there are so many different types of ETFs. However, over the long term, ETFs tracking the S&P 500 index have historically delivered a return of about 10% per year.
What is the average return on mutual funds? The average return on mutual funds varies depending on the type of fund. However, over the long term, most stock market-based mutual funds have returned around 7-10% per year.
Which are best for beginner investors? If you’re just starting out in the investment world, ETFs tracking broad market indexes like the S&P 500 can be a good choice. That’s because they offer diversified exposure to the stock market at a low cost.
Based in London, Edward is a distinguished investment writer with an extensive client portfolio comprising a diverse array of prominent financial services firms across the globe. With over 15 years of hands-on experience in private wealth management and institutional asset management, both in the UK and Australia, he possesses a profound understanding of the finance industry.
Before establishing himself as a writer, Edward earned a Commerce degree from the prestigious University of Melbourne. Complementing his academic background, he holds the esteemed Investment Management Certificate (IMC) and is a proud holder of the Chartered Financial Analyst (CFA) qualification.
Widely recognized as a sought-after investment expert, Edward’s insightful perspectives and analyses have been featured on sites such as BlackRock, Credit Suisse, WisdomTree, Motley Fool, eToro, and CMC Markets, among others.
You can contact Ed at edward@goodmoneyguide.com
