ETFs vs. Mutual Funds
Unless you’re new to investing, you have probably heard about the existence of ETFs and mutual funds. They are two funding types that help investors add some diversity to their portfolio. However, beginner investors often find themselves in the middle of a hard choice-making process: which one of the two is worth investing in? What are the advantages and drawbacks of the two? Read this article to find out exactly that.
What Are ETFs and Mutual Funds?
Before we break them down into pros and cons, let’s see what each of them is.
ETF is short for “exchange-traded fund”, and these funds are basically securities that you can either sell or purchase through stock exchanges or brokerage firms. They include a wide range of investing options, such as bonds, commodities, and many others. In addition, they come in multiple types, including industry ETFs, inverse ETFs, bond ETFs, commodity ETFs, and currency ETFs.
Meanwhile, mutual funds refer to an investment vehicle. Basically, it’s something that collects cash from investors, after which money is invested in bonds, stocks and others.
What Are the Pros and Cons of ETFs?
- Pros
- You won’t stay in the market for too long if you don't want to. ETFs are very easy to sell and purchase, offering you the chance to come and go throughout the trading day.
- The fees are low.
- There is no minimum holding period when it comes to these funds.
- Through an ETF, you will gain easier access to commodities, gold, emerging stock markets, and many others.
- With this funding type, you’ll have the chance to use bond and stock index ETFs, thus gaining the opportunity to invest your assets.
- Minimum investment is low. (1 share or even partial shares depending on your broker)
- Wide variety of choices.
- Can allow you to leverage.
- Cons
- Funds take 2 days after the trade is executed to be settled whereas mutual funds settle the next day.
- If you have an actively managed ETF, then the fees are going to be higher, but not higher than an actively managed mutual fund.
- Some ETFs only focus on certain industries, which don’t offer as much diversification as you may want. But if that’s the case, you can always buy more than one ETF.
What Are the Pros and Cons of Mutual Funds?
- Pros
- There is a lot of diversification to obtain from them, potentially being beneficial to your portfolio.
- You have a wide variety of offerings.
- A mutual fund is managed by a professional with lots of market experience and knowledge.
- You get liquidity on a daily basis, meaning that as an investor, you can redeem your shares whenever you want.
- You get special access to certain investments, that you might not be allowed to get unless you are bigger in the investing area.
- Cons
- Your portfolio will have a big cash presence because the fund is never fully invested.
- It won’t be as easy for you to make a comparison between funds.
- You will have to deal with commissions, and fees which can be expensive.
- You won’t be covered by an FDIC or CDIC insurance.
- You can’t day trade them.
- Mutual funds often underperform the market (S&P 500).
Our Opinion – ETFs are Much Better
In our opinion, ETF’s are much better than mutual funds. If you are on this page, you’re already an investor who is seeking above average returns. You are an active investor that has an interest in what you own and want to be able to buy and sell whenever you please. Mutual funds are more costly and under perform the market most of the time. Why would you pay a fund manager all those fees to give you below average returns?
With an ETF, you can have broad exposure to the market by buying an ETF such as the SPY that tracks the S&P 500 which will give you exposure to 500 companies. If that is not enough exposure for you, add a bond ETF to the mix. If those 2 aren’t enough, add commodity ETFs to the list! There are many types of ETFs to suit everyone’s needs.
If you are willing to take the risk, ETFs can also allow you to leverage. For example, there are leveraged versions of the SPY ETF. An example of a leveraged ETF is SPXL. This tracks the S&P 500 but exaggerates its moves by 3x. Meaning if the SPY is up 1%, SPXL will be up 3%, and vice versa. Investors definitely need to be careful with leveraged ETFs, but at least the option is there and one buy and sell it as many times as he wants during the trading day.
If you can’t stand the volatility of the market, there are also low volatility versions of certain ETFs. An example of one is SPLV. This is a low volatility version of the SPY ETF. You will have exposure to the stock market while keeping volatility relatively low. The great thing about these types of ETFs is that they don’t usually underperform the index that they track. In fact, lots of times they outperform it. Below is a chart of SPY’s performance compared to SPLV.
SPLV in red, SPY in blue. The low volatility ETF has similar performance but less downside risk.
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FAQs
Key Takeaways. ETFs offer easy access to a diversified portfolio of assets. They're traded on stock exchanges throughout the trading day, providing you with the flexibility to buy or sell shares at market prices. ETFs typically have lower expense ratios than mutual funds because more of them are passively managed.
Why are ETFs better than mutual funds? ›
Less paperwork equals lower costs. Most of the time. Transparency: ETF holdings are generally disclosed on a regular and frequent basis, so investors know what they are investing in and where their money is parked. Mutual funds, by contrast, are required to disclose their holdings only quarterly, with a 30-day lag.
What are the drawbacks of mutual funds (ETFs)? ›
Disadvantages of ETFs
- Trading fees.
- Operating expenses.
- Low trading volume.
- Tracking errors.
- The possibility of less diversification.
- Hidden risks.
- Lack of liquidity.
- Capital gains distributions.
Equity and bond ETFs: Capital gains
Although similar to mutual funds, equity ETFs are generally more tax-efficient because they tend not to distribute a lot of capital gains.
What is the main difference between ETFs and mutual funds Quizlet? ›
Unlike mutual funds, an ETF trades like a common stock on a stock exchange. ETFs experience price changes throughout the day as they are bought and sold. *ETFs typically have higher daily liquidity and lower fees than mutual fund shares, making them an attractive alternative for individual investors.
What could be an advantage of ETFs over mutual funds? ›
Exchange-traded funds (ETFs) take the benefits of mutual fund investing to the next level. ETFs can offer lower operating costs than traditional open-end funds, flexible trading, greater transparency, and better tax efficiency in taxable accounts.
Why are ETFs more safe? ›
Most ETFs are actually fairly safe because the majority are index funds. An indexed ETF is simply a fund that invests in the exact same securities as a given index, such as the S&P 500, and attempts to match the index's returns each year.
Which is riskier ETF or mutual fund? ›
The short answer is that it depends on the specific ETF or mutual fund in question. In general, ETFs can be more risky than mutual funds because they are traded on stock exchanges.
Why is an ETF not a good investment? ›
ETFs are subject to market fluctuation and the risks of their underlying investments. ETFs are subject to management fees and other expenses.
What is the best ETF to buy right now? ›
Top U.S. market-cap index ETFs
| Fund (ticker) | YTD performance | Expense ratio |
|---|
| Vanguard S&P 500 ETF (VOO) | 15.7 percent | 0.03 percent |
| SPDR S&P 500 ETF Trust (SPY) | 15.7 percent | 0.095 percent |
| iShares Core S&P 500 ETF (IVV) | 15.7 percent | 0.03 percent |
| Invesco QQQ Trust (QQQ) | 18.0 percent | 0.20 percent |
ETFs offer easy access to a diversified portfolio of assets. They're traded on stock exchanges throughout the trading day, providing you with the flexibility to buy or sell shares at market prices. ETFs typically have lower expense ratios than mutual funds because more of them are passively managed.
Why are ETFs better than mutual funds in taxable accounts? ›
ETFs are generally considered more tax-efficient than mutual funds, owing to the fact that they typically have fewer capital gains distributions. However, they still have tax implications you must consider, both when creating your portfolio as well as when timing the sale of an ETF you hold.
What are ETFs pros and cons? ›
In addition, ETFs tend to have much lower expense ratios compared to actively managed funds, can be more tax-efficient, and offer the option to immediately reinvest dividends. Still, unique risks can arise from holding ETFs as well as tax considerations, depending on the type of ETF.
What is best ETF or mutual funds? ›
ETFs have lower expense ratios. Mutual funds have higher management fees. ETFs are passively managed, mirroring a particular index, making them less risky and transparent. Mutual funds are actively managed, with fund managers investing based on analysis and market outlook.
Do ETFs have higher expenses than mutual funds? ›
ETFs expense ratios generally are lower than mutual funds, particularly when compared to actively managed mutual funds that invest a good deal in research to find the best investments.
What is the main advantage of using mutual funds? ›
Mutual funds offer diversification or access to a wider variety of investments than an individual investor could afford to buy. Investing with a group offers economies of scale, decreasing your costs. Monthly contributions help your assets grow. Funds are more liquid because they tend to be less volatile.
How do ETFs avoid capital gains? ›
Sources of Tax Efficiency
These gains are taxable for all fund shareholders. By contrast, ETF managers accommodate investment inflows and outflows through the in-kind share creation and redemption process, which enables them to shed securities that may generate significant capital gains.
Should I switch my mutual funds to ETFs? ›
If you're paying fees for a fund with a high expense ratio or paying too much in taxes each year because of undesired capital gains distributions, switching to ETFs is likely the right choice. If your current investment is in an indexed mutual fund, you can usually find an ETF that accomplishes the same thing.
Are ETF good for long term? ›
Units of such ETFs can be held for a long term as a part of the core portfolio. Investors can also use these ETFs to complement their trading or investment style to achieve diversification. For example, an aggressive trader going after momentum trades, can park some money in the units of low volatility ETF.
Which ETF gives the highest return? ›
List of 15 Best ETFs in India
- Kotak Nifty PSU Bank ETF. 205.5%
- Nippon India ETF PSU Bank BeES. 200.8%
- BHARAT 22 ETF. 191.7%
- ICICI Prudential Nifty Midcap 150 Etf. 106.6%
- Mirae Asset NYSE FANG+ ETF. 80.6%
- HDFC Nifty50 Value 20 ETF. 72.4%
- UTI S&P BSE Sensex ETF. 59.0%
- Nippon India ETF Nifty 50 BeES. 57.9%
