ETF vs. Mutual Fund: Which is Better?

When trying to figure out whether you should invest in ETFs or a Mutual Fund, things can get overwhelming.

There’s so much that goes into each one and you can easily get lost if you aren’t really sure what you’re doing.

We’ve put this guide together to help you decide if ETFs or a Mutual Fund is better for your needs.

What is an ETF?

ETFs are Exchange Traded Funds. Basically, it’s an investment that’s open-ended and traded in the stock market. It’s made up of something called a basket of securities or assets, which you want to copy the performance of an index. Just like normal stocks, ETFs have prices that change throughout the day depending on the price and demand of that particular share.

What is a Mutual Fund?

The two mutual fund types we’re going to talk about are index and actively managed. Both of these have their own advantages and disadvantages, which we talk about below. They both are perfect for different situations, so make sure you get all the information you need.

Similarities of ETFs and Mutual Funds

Before getting into more in-depth information for ETFs and Mutual Funds, it’s important to know how they are similar and how they’re different. In addition to using the detailed information listed below, you can use these similarities and differences to help you decide which is best for your needs.

There are a few similarities to both of these, so we decided to talk about them more below.

Both are Less Risky

Both of these are quite a bit less risky than traditional stocks. Since these usually have multiple stocks in each pick, there’s a higher chance you’ll get a return even if some of the stocks aren’t doing well. There’s always the chance that all of the stocks are doing poorly, but it doesn’t happen too often. Since you’ll have stocks available to compensate for any that aren’t doing well, you’ll have a lower overall loss.

Stock & ETF Trading Signals

Both Have Several Investment Options

Not only can you choose from several different options, but you can also choose one that has multiple stocks bundled together. This gives you a chance to get a higher return while you’re total losses are lower. If you choose to go with a bundle, make sure you look at the stocks that are included. Try and choose something that has a lot of stocks with high returns.

Both are Managed by Professionals

Both a mutual fund and ETFs can be overseen by professionals. You’ll set a goal or give guidelines and the professional will choose stocks based on them. You don’t have to use a professional if you want but remember that they’re trained and know what they’re looking for. They also have information about all of the different stocks that will help guide them in the right direction.

Differences Between ETFs & Mutual Funds

On the other hand, the differences could make or break your decision. We’ve listed some differences below to really help you understand how they differ.

How They’re Sold

ETFs can be bought if you have a brokerage fund, while a mutual fund is sold by the brokerage or investment company that owns them. Some investment companies won’t offer stocks that are owned by other companies, but some will offer not only what they own but some of their partnering companies as well. If you’re looking for mutual options, you should check out a company that sells both.

How They’re Priced

Another big difference between the two is how they are priced. A mutual fund is priced once a day after the stock market has closed, while ETFs change in price like traditional stocks. This means that there’s a higher chance of taking a large loss if you use ETFs than you would by using a mutual fund. On the other hand, you could else get a huge return depending on the market conditions.

ETFs are Cheaper

ETFs are generally cheaper than a mutual fund. Not only do they need more people to operate them, but some will charge a commission fee. Everything ends up being more expensive because they need the money to operate and pay all of the people on their team. If you only have a certain amount of money, you’ll want to know what these fees are upfront.

Mutual Funds Have Higher Minimums

A mutual fund will have a minimum amount that you have to invest. This could be a low amount or it can get into the multiple digits. On the other hand, ETFs don’t require any minimum amount. The price you’ll pay is how much a single share costs on the market at the time of purchase. If you have the money, a mutual fund has a better chance of a higher return.

ETFs Have Tax Advantages

Another thing that brings down the total operating costs is the tax benefits. The buying and selling of ETFs are done by outside companies, which means the holders of the shares aren’t liable for any capital gains unless they sell their shares personally for some kind of profit. If you’re concerned about the operating cost amount, it’s a good idea to go with an ETF.

All About ETFs

ETFs are Exchange Traded Funds. Basically, it’s an investment that’s open-ended and traded in the stock market. It’s made up of something called a basket of securities or assets, which you want to copy the performance of an index. Just like normal stocks, ETFs have prices that change throughout the day depending on the price and demand of that particular share.

If any of the things listed below matches your situation, then ETFs might be a good idea.

Active Trading

ETFs are great for those that trade actively. A mutual fund doesn’t allow short selling, stop orders, intraday trading, or limit orders. This means you’ll have less choice and options to choose from. ETFs have all of these with plenty of options in each. If you’re someone that wants to have many options and chances to get a large return, you should check these types of funds out.

Niche Exposure

Another great thing about ETFs is that they can make it possible to get niche exposure. There are ETFs that are focused solely on niche markets, services, and products. You’ll also have the chance to find out about markets you might not have considered. Most of the time, a mutual fund won’t have these options but there are some managed niche funds that might have a few niche options available.

Stock & ETF Trading Signals

Tax Efficient

One last consideration is the tax-efficiency of EFTs. The biggest reason for this is that ETFs don’t produce as many capital gains as a mutual fund. The less capital gains produced means the more tax-efficient things will be. One thing to keep in mind is that you can only get untaxed events while you own the ETFs. As soon as you sell, you won’t get this benefit anymore.

Disadvantages of ETFs

Some disadvantages of ETFs are listed below.

Larger Bids & Ask Spreads

When you buy and sell ETFs, the price they give you is usually less than the actual value, which is the NAV. The difference in these is called the bid/ask spread and it’s usually quite small and doesn’t make much difference. For niche markets that aren’t traded as much, though, the spread can be quite large. This can lead to extra fees and losses.

Creeping Fees

Another big drawback about ETFs is that they tend to have creeping fees. Most of the time, they’ll offer a lower price for a limited amount of time. Some companies will extend these offers but some will let it run out. If this happens, you’ll get an expense ratio that will end up being higher than what you originally had. Any potential investors will be able to see all of this information.

All About Mutual Funds

The two mutual fund types we’re going to talk about are index and actively managed. Both of these have their own advantages and disadvantages, which we talk about below. They both are perfect for different situations, so make sure you get all the information you need.

These types of funds might be better if you’re looking for either of the things listed below.

Lower Operating Expenses

There are some index funds out there that have a lower annual operating expense than most ETFs. While there aren’t as many options to choose from, you might find one you can work with. Keep in mind, before choosing one of these, you’ll want to compare things like returns and losses. If the numbers are worse, it might not really be worth it in the long run.

Less Thin Trading

The biggest reason why this is a benefit is because you don’t have to worry about losing money on a larger bid/ask spread. As stated above, ETFs have a higher chance that you’ll have discrepancies between what you pay and how much the actual value is. With an index fund, you’ll always buy and sell at the NAV price and you won’t have to deal with any bid/ask spread.

Disadvantages of Mutual Funds

If you want to know what the disadvantages might be, take a look at the items listed below.

Never Outpace Market

Unfortunately, these types of funds won’t be able to beat an actively managed fund that performs at the top. The reason is because an index fund is tied directly to the way the index performs. In addition, these funds tend to be more slow and steady instead of fast and unpredictable. You’ll see more long-term gains but you’ll only have a small amount, if any, short-term.

No Holdings Control

With these fund types, you have no control over any holdings. This means you might find an index that has companies you like as well as companies you don’t. Even if this is the case, you won’t be able to change it. The good thing is that most will have a pretty good mixture, so there’s a chance you’ll have more options to get gains instead of losses.

No Downside Protection

One other drawback is that you have no downside protection. This means your index goes down if the market does. This can cause you to lose quite a bit and you won’t have that extra layer of protection to make that loss a bit easier. While some of the more popular options for these funds tend to be a good investment, you never know when the market will take a downturn.

Conclusion

For the most part, ETFs are safer than a mutual fund. The biggest downfall is that you’ll be playing on the safer side and might not see as big of a return. This isn’t always the case, though, so make sure you check out the specific ETFs or mutual fund you might be interested in.

As you can see, both ETFs and a mutual fund have their own advantages and disadvantages. With this being the case, it can be hard to answer which one is the best. It’s going to come down to specific people and their needs or situations. If you aren’t sure which is right for you, don’t be afraid to reach out to a professional!

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