Mutual funds vs ETFs: are ETFs a better investment?
Mutual funds and exchange traded funds (ETFs) are more similar than not.
They are both baskets of many stocks, bonds, and other securities that help you spread your investments in the stock market. Instead of selecting single assets yourself, you can use either type of fund to instantly get hundreds, thousands, or tens of thousands of different stocks and bonds.
“Imagine going to a restaurant and wanting to try a bit of everything on the menu. Instead of buying an individual dish, you decide to buy the tasting plate, ”explains Rita-Soledad Fernández Paulino, financial educator at Wealth Para Todos. “Mutual funds and ETFs are the sample plates. “
Read on to learn more about mutual funds and ETFs and how to decide which one is right for you.
Mutual funds vs ETFs: similarities and differences
Investors love both mutual funds and ETFs because of the way they allocate money in the stock market. This lowers your risk and prevents you from investing in a single stock, which can hurt you if that business goes down.
There are a few key differences that distinguish mutual funds and ETFs.
How they are managed
ETFs and mutual funds can be index funds, which means they track the performance of a certain market or index. There are many index funds out there, but those that mirror the S&P 500 (the 500 largest publicly traded companies in the United States) are often recommended.
Pro tip
Mutual funds and ETFs are low risk investments, even for beginners. Newbies may want to look into ETFs first before moving on to mutual funds, although the two work pretty much the same.
The best ETFs are passively managed, which means they track a specific index rather than having a fund manager choose the stocks. These ETFs will have lower expense ratios or fees and generally have no commissions, making them experts’ favorites. There is usually no minimum required to start investing with ETFs, and ETFs also offer tax advantages to investors.
On the other hand, some mutual funds can be actively managed, usually by an account manager. So the difference here is that the purchase may cost more.
How they are traded
Like stocks, ETFs are bought and sold on the stock exchange. ETFs therefore see constant price fluctuations throughout the day. Mutual fund orders only go through once a day, where buyers and sellers get the same price.
“ETFs are bought and traded like stocks, which means you can buy for the price of a stock,” says Paulino. “Mutual funds are bought at a fixed price. This can make buying ETFs more affordable.
What they cost
ETFs generally have lower fees than mutual funds and lower minimum purchases. “Returns can fluctuate, but costs are more constant with ETFs,” says Cait Howerton, Certified Financial Planner and Senior Planner at Facet Wealth.
You can buy an ETF for as little as the cost of a stock, and that cost varies depending on the ETF. For example, it could be a few dollars or a few hundred dollars.
Many mutual funds have minimum initial investments that are not based on the fund’s share price. Remember that mutual fund orders are placed once a day, so they have a fixed amount.
When can you buy mutual funds and ETFS
You can buy mutual funds and ETFs through a bank, investment company, fund manager, brokerage account, or any other company that buys them and sells them. If you have actively managed accounts, you can contact your account manager to purchase specific accounts.
Do ETFS and Mutual Funds Pay Dividends?
Mutual funds and ETFs have the ability to pay dividends, but it depends on each fund.
If a mutual fund or ETF has a stock or other security that pays dividends to its shareholders, that mutual fund or ETF will return the dividends to you, the investor. You can also realize capital gains through a mutual fund or ETF.
Which one is the safest?
Mutual funds and ETFs are considered low risk investments compared to handpicked stocks and bonds. While investing in general always comes with some level of risk, mutual funds and ETFs have roughly the same level. It depends on the mutual fund and ETF you are investing in.
“Neither an ETF nor a mutual fund is safer simply because of its investment structure,” says Howerton. “Instead, ‘safety’ is determined by what the ETF or mutual fund has. A fund with a greater exposure to equities will generally be riskier than a fund with a greater exposure to bonds. “
Because some mutual funds can be actively managed, it is possible that these funds will outperform and underperform in the stock market, says Paulino.
Mutual funds or ETFs: which one to choose?
The fund you choose depends on many factors, such as what type of investor you are, the fund, the type of account you have and your overall strategy. Howerton says ETFs are a great place to start.
“Because of the much lower costs, ease of purchase, and tax efficiency, ETFs are hard to beat,” she says. The overheads on ETFs are much lower than on mutual funds, which could be a deciding factor. Pay attention to expenses and fees when choosing between mutual funds and ETFs. Every little charge adds up.
“A newbie investor should start with passively managed mutual funds or ETFs that have low expense ratios,” Paulino said. “Anything below 0.5% is great and keep in mind that some expense ratios can be as low as 0.02%. In order to reduce taxes payable, they should start by investing in tax-efficient accounts like a Roth IRA.