Both a mutual fund and an ETF work through pooled investments from a variety of different investors, both putting money into the market seeking favourable returns. But what’s the difference?
An ETF or exchange-traded fund, is a form of investment that tracks a certain index or sector. This could be the S&P 500, commodities, bond market or technology, there are loads of choices for all types of investors who believe in the index or industry they think will thrive. They hold a large amount of stocks, bonds, commodities depending on the ETF you choose, which will match the market. This is seen as great for beginners due to more cost effective pricing and will guarantee returns if whatever the ETF is tracking does well. The most popular ETFs are those from Vanguard and Fidelity, who compete by offering extremely low expense ratios, with Vanguard’s S&P 500 ETF only reaching 0.03%.
A mutual fund is much older than its investment brother the ETF. When you invest in a mutual fund you’re trusting the companies fund managers to pick stocks and other holdings for you they think will do well. Mutual funds will normally offer a range of different funds, differing in everything from: types of investments, countries invested and volatility (risk). Although you can get passive funds (index mutual funds) that are similar to ETFs, most are actively managed and you’ll be paying a premium for their service. The commission rate is normally between 0.5% to 2% annually, but a range of other fees could also be implemented depending on the mutual fund. The fund will also vary in minimum initial investment, however these will be much higher than ETFs.
Although we have explained a brief overview over how they operate, the main differences are characterised by the table below:
| The differences | ETF | Mutual Fund |
| Price | An ETF will often have a much lower buy in cost. Paying for 1 share will vary around a few hundred dollars to under $30. Easier for those investors who want to get started without needing much capital. | Mutual Funds aren’t based on market prices but flat rates. These minimum initial investments will be $1000+ in most circumstances. |
| Price Fluctuation & Stock Orders | An ETFs price will fluctuate throughout the day, therefore the time at which you place your order will affect the price you purchase at. However, unlike Mutual Funds this allows for stock orders to be put on. | Mutual Funds price will remain the same during the day, only after the trading day is over will the new price be calculated. |
| Active or Passive | ETFs tend to be passive investments, with few active funds around. Holding a large collection of stocks to emulate a certain market e.g. SnP 500 or the gold market. | Mutual Funds can be both actively and passively managed. With passive funds also emulating markets, while active funds attempt to beat the market in favour of higher returns. |
| Expense Ratio | ETFs, in particular Vanguard and Fidelity, offer low expense ratios due to the fact that they just buy and hold a large amount of stocks, this means that there aren’t large transaction fees. | Passive mutual funds will have lower expense ratios as following ETFs will just track a market. Active mutual funds will often have higher expenses attached due to the higher daily trading of stocks and fund manager fees. |
Summary
So which one is better then? They depend on your style of investment. For those who are quite happy matching the market, either an index mutual fund or an ETF would be suitable as long as you have the money for the minimum initial investment. The main factor to look at between the two when choosing would be the expense ratio. This will differ from fund to fund so make sure to look out for it, as this will be pivotal in long term gains.
If you’re looking for something a bit riskier for your portfolio, an actively managed mutual fund can also work. People use these types of mutual funds to be able to invest in emerging economies and other foreign markets without the need for specialist knowledge, due to the complex rules and legislation of different countries and markets. Some mutual funds have been able to beat the market consistently year on year, however very few achieve this over a long period of time, 20+ years, as shown above. Investors always have the choice to invest in both so as to vary their portfolio, to ensure steady gains whilst also being open to the chance of higher returns. This could be represented through a Dow Jones ETF and a St. James Place mutual fund.