ETFs vs. Mutual Funds

ETFs vs mutual funds, which one is better for me?

Ali vs Frazer. Magic vs Bird. McEnroe vs Borg. All three have brought endless hours of debate on who is superior.

As of the last decade in the world of finance that rivalry has been ETFs vs. Mutual Funds.  ETFs track an index, such as the S&P 500 or the Dow Jones Industrial Average. ETFs can also be formed to track specific sectors such as gold and even IPO announcements.

In review, a mutual fund is a collection of different shares of individual stocks and bonds that are chosen by the fund manager. 

For the past half century, mutual funds have been a popular choice for investors worldwide. ETFs being relatively new (the first ETF came out in the early 90’s) have made great strides to becoming the most popular means of investing due to their low cost and tax advantages.

Cost

Both mutual funds & ETFs charge their shareholders a fee called an expense ratio. The expense ratio is essentially what you, the shareholder pay to own the stock.

The charges don’t end there for Mutual Funds.

Mutual funds carry 12b-1 fees while ETFs do not. 12b-1 fees cover mutual fund expenses such as advertising, marketing, and distribution fees. Think of it as an expense to operate. In addition, the person selecting and managing the fund has to eat too! The manager of the mutual fund charges an ongoing fee for managing the fund as well.

Although these fees may seem minimal, they can certainly add up over the long haul. It should come as no surprise that mutual funds on average have much higher expense ratios than ETFs.

Trading

How these investments trade remains one of the main differences in the argument “ETFs vs mutual funds”

ETFs are much more flexible in terms of trading. ETFs trade exactly like a stock, at any point throughout the day.

Mutual funds, on the other hand, are priced and traded at the very end of the day. Mutual funds often require a minimum investable amount, unlike exchange traded funds.

Because exchange traded funds are similar to stocks and have no minimum investment requirements they are very popular with beginner and smaller scale investors that may have not been able to build up their investable assets.

Clarity

Do you ever get frustrated when you order food and you receive something completely different? Mutual Fund investing is somewhat similar.

Under SEC regulation, mutual funds must publish their holdings within 60 days of their quarter end.  With mutual funds buying and selling securities every day it becomes difficult in observing what exactly you bought.

If you hold multiple mutual funds in your portfolio this can present a problem and can result in fund overlap. Fund overlap exists when a person holds multiple mutual funds that hold the same securities and reduces the overall diversification benefit.   

Tax Efficiency

ETFs are extremely tax efficient.

ETFs perform transactions within the fund that allow buying and selling assets without triggering a taxable event also known as a "like-kind exchange".

On the other hand, mutual funds typically have capital gains. This is due to redemptions that the fund manager executes year round. Since a mutual fund is a pass-through entity like a sole proprietorship or an LLC, the shareholders are on the hook for any taxes that the fund manager triggers.