ETF vs. Mutual Fund- Which is Better?

Jan 18, 2022

ETF vs. Mutual Funds

Choosing where to invest your money is pivotal when planning for the future. It can make or break your bank. There are countless options to choose from, including ETFs and mutual funds. So which one do you choose?
To help you make a decision, let’s learn more about the components of each type of fund first.

What Is a Mutual Fund?

A mutual fund is one of many ways to invest your money today, saving for future retirement. It is an SEC-registered, open-end investment company.

What Does a Mutual Fund Do?

Mutual funds share an investor’s money between stocks, bonds, and many other combinations of investments. This pool of investments is also referred to as an investment portfolio.
They help prepare you for retirement.

What Are the Types of Mutual Funds?

Mutual funds have several categories. Below are 4 common categories:
  • Money market funds - these funds are low risk, focusing on short-term investments issued by corporations and governments.
  • Bond funds - focus on investing in bonds, with a goal of providing higher returns than that of money market funds.
  • Stocks funds - vary in structure but focus on investing in corporate stocks.
  • Target date funds - also known as lifecycle funds, are created based on a set retirement date mixing stocks, bonds, and more to reach the funds’ financial goal.

Why Should You Choose a Mutual Fund?

Mutual funds are a popular choice amongst investors. Below are a few reasons why.
  • Full-service investment option - fund managers are on-site waiting to work with you, plus they do the work. Professionals are in charge of managing your mutual funds, selecting the best fit for your portfolio, and monitoring their performance.
  • Provides an assorted portfolio - with a mutual fund, your portfolio includes various types of industries and companies. Diversifying your portfolio is advantageous, which may lower risk in the event a company goes off the deep end unexpectedly.
  • Quick to liquidate - if mutual funds need to be redeemed, no time is lost. The current net asset value is returned, fewer fees, at any time.
  • Variety to choose from - people like when they have options, and mutual funds give them just that.
  • Systematic deposits and withdrawals - investing doesn’t require a large amount to put in, and withdrawals can go straight to a bank account.
  • Automatic reinvestment - reinvest capital gains and dividends with mutual funds.

What Is an ETF?

The acronym ETF stands for exchange-traded funds. It works similar to that of a mutual fund and a conventional stock blended together.
Under the Investment Company Act of 1940, an ETF must register with the SEC as an open-end investment company or a unit investment trust (UIT).
UITs result in a one-time public offering of a fixed amount of redeemable securities, or units. At closing, a termination date is assigned to these units.  
Like a mutual fund, an ETF is a pooled investment fund. The difference? It functions like a stock. It is traded on stock exchanges and bought or sold at prices that fluctuate. It also tends to have a lower price tag.
Much of that has to do with its management style being primarily passive.

What Are the Types of ETFs?

The majority of ETFs use index tracking. This means they work hard to match an index’s returns or price movements.
Not sure of what an index is? Don’t worry.
Indexes typically measure the performance of a basket of securities intended to replicate a certain area of the market.
As the prices move up and down, they are documented for future use and used to predict behavior changes and outcomes.
There are two types of ETFs:
  • Index-Based ETF shares
  • Actively Managed ETFs
Index-Based ETFs
Index-based ETFs make up the majority of the market. These are considered passively managed, striving to replicate the performance and trend found in a designated index. There is not as much flexibility with an index-based ETF as there is with an actively managed one since they can not be altered at the turn of a dime.
Check an ETFs website. It is possible that they post their holdings on a daily basis.
Actively Managed ETFs
The rest of the ETF market is made up of actively managed ETFs. These are not based on an index. Instead, professionals make the underlying decisions for a portfolio’s allocation to try and outrun the market. Actively managed ETFs come at a higher cost than their passive partners but are usually less expensive than mutual funds.

How To Buy and Sell ETFs

Buying and selling ETFs is simple; you just need to know what to look for. ETFs are bought and sold through brokerage accounts, such as Fidelity and Robinhood, to name a couple. You can buy and sell ETFs all day if you’d like, paying the listed price at the time of sale. You don’t have to sit around and wait until the end of the day as you would with a mutual fund since most only trade once per day.
A brokerage firm can help you select an ETF through screening tools available on their website. Or, you can research to find an ETF built for your needs, such as saving for retirement, a home, a vacation fund, or childcare.
What you will need to vet is:
  • Asset class - majority focus on stocks and bonds, but ETFs can include commodities such as gold and silver and more.
  • Geography - invest abroad?  Or stay within the United States?
  • Segment - how the assets are categorized - for example, by company size, industry, etc.
  • Investment style - do you want an actively managed fund, or a passive? Are you interested in growth, or would you prefer value?
  • Holdings - these are made public each day and are good to check if you are on the hunt for a specific holding in the mix.
  • Expenses - some ETFs are cheaper than mutual funds, making them a hot topic. However, there are others that are expensive. Fees vary by provider and by the fund, so check the fine print.
  • Performance - look at the historical trends.

Why Choose ETFs?

Since most ETFs are passive investments, your expense ratios can be significantly lower than those charged by active investments.
Passive ETFs are also tax efficient. They don’t require continuous trading, and the way they are structured minimizes the effect of capital gains.
In fact, ETFs use in-kind practices to keep the costs down, swapping instead of selling on the market. These are just a few reasons ETFs can be a smart choice for your portfolio.

Important Take-Aways

Both a mutual fund and an ETF are options for your investment. One is not necessarily better than the other. It all depends on your strategic plan.
Before investing in mutual funds or ETFs, remember that neither are guaranteed or insured by the FDIC.
Both ETFs and mutual funds are assessed annual fees. These fees include management fees, 12b-1 fees (exclusive to mutual funds for marketing expenses), account fees, and more.
It is listed as your expense ratio. ETFs tend to have lower fees as they are passively managed, do not have set commissions, and participate in market-based trading.
Be aware of the bid spread or ask spread with ETFs. Some may be larger than anticipated. For example, the price you are given when you choose to buy or sell an ETF could be less than the net asset value. If you are niche investing, the spread can be wide.

The Bottom Line

Don’t rush into investing into an ETF or a mutual fund unless you understand it’s strategy and it meets your overall financial goals. Each is built and tailored to a different audience. If you are uncertain, don’t be shy. Reach out to a financial advisor or a professional you trust for guidance on these complex products.
LifeGoal Investments is here to help you understand the importance of investing. They have various ETF investments available to help you strategically build a financial portfolio so that you can focus on today and be prepared for the future.
How Mutual Funds, ETFs, and Stocks Trade | Fidelity
INVESTMENT COMPANY ACT OF 1940 [Chapter 686 of the 76th Congress] [As Amended Through PL 115–174, Enacted May 24, 2018] Be i | GovInfo
Mutual Funds and ETFs | SEC
Mutual Funds |