ETFs or exchange traded funds, are very popular these days. I get asked all the time if they are better than mutual funds and how they differ from one another.

When talking about ETFs vs Mutual Funds, we need to start by looking at the definition of what an index is: “An index is a statistical calculation that measures the movement of a stock index. It is a measure to a set scale, usually representing the movements in a market as a whole.”

ETFs are funds that have indexes associated with them and instead  of buying one company’s entire portfolio like you do with individual stocks, you buy into the ETF which holds multiple companies inside it. This diversity goes a long way to providing less risk in your investment.

ETFs are traded like stocks on an exchange, and that means there is always a bid/ask spread. The price you see quoted for an ETF is the ask price. To get the bid price, you would subtract about 0.20% off the ask.

The other thing to remember is that if you’re going to invest in ETFs, they are NOT a buy and hold investment. We’ll talk about the reasons later.

Let’s start by comparing an ETF to a mutual fund.

Mutual Funds vs. ETFs

There are several differences between the two:

#1 Mutual funds have prices based on the Net Asset Value, or NAV. ETFs have prices based on supply and demand of their stock.

#2 Mutual funds are priced only at the end of the day, but ETFs are priced very second during market hours.

#3 A mutual fund has a minimum investment amount required to start investing, which is usually $500-$1,000. ETFs can be bought in small amounts like $25-$50 and some like Vanguard even have a minimum of $100.

#4 A mutual fund has 12b-1 fees that go into the management fee; an ETF does not charge these fees.

#5 Mutual funds reinvest dividends and capital gains, but you need to pay taxes on those. ETFs do not reinvest dividends and capital gains, which is beneficial because you pay less in taxes.

#6 Mutual funds are bought directly through the fund company or financial planner, but ETFs can be bought  like any other stock through an online broker or discount broker.

So with all these benefits to using an ETF, why would I ever use a mutual fund?

The answer is simple: because it’s a completely different product. You shouldn’t compare an apple to an orange.

ETFs have outperformed Mutual Funds over the past 5 years, but the majority of people still prefer mutual funds because they are so much easier to understand and their investment strategy is known by many. If you’re not comfortable with picking individual stocks, the ETF is not the product for you.

You also need to understand that with ETFs, you can easily double or triple your money depending on what’s happening in the market… but it can also go down just as fast if something goes wrong. Many people haven’t put their money back into the market because they’re afraid of what will happen to their initial investment.

ETFs are NOT a buy and hold investment vehicle, so don’t invest money that you cannot afford to lose. If you have extra cash to put towards an investment account, ETFs are definitely worth looking into.

I hope this has shed some light on the differences between an ETF and a Mutual Fund. Please feel free to email me with any questions or concerns.