ETFs and mutual funds are very similar in principle: both are investment vehicles based on the idea that small investors can pool their money and collectively invest in a wide variety of financial instruments. For one thing, this provides an effective way to diversify a portfolio.

However, there are some differences in the ways in which these funds are managed and the choices available to you when investing in either. While deciding whether to invest in one or the other may come down to a coin flip for you, most people will be well advised to take a closer look at the fit each offers to their personal circumstances.

In this article, we’ll explore ETFs vs mutual funds and hopefully help you decide which is the best investment option for you.

Contents: ETFs vs mutual funds

• Similarities between ETFs & Mutual funds
  • Pooled investments with other investments into a basket of assets
  • Automatic diversification
• Differences between them
  • Higher minimum deposit for mutual fund
  • Expense ratio / costs
  • ETFs give you more control over buy/sell price
  • Mutual funds offer automated scheduled investments, which can be taken directly from salary if investing through a work pension scheme
• Which one is right for you?
  • A consideration of asset types might be a bigger consideration than the structure of the fund

Reminder: What is an ETF?

ETF stands for Exchange Traded Fund; their primary characteristic is therefore that investors can buy shares in ETFs on a stock exchange just like they would purchase stocks. The money various investors deposit in this way is pooled together and invested in a basket of stocks, bonds, and other securities. The whole shebang is under the supervision of an ETF management team, which provides greater expertise than any part-time investor can claim to have.

For the sake of simplicity and stability, most small investors prefer to put their capital in popular ETFs that aim to track an index such as the S&P 500. Since the goal is not to outperform the market, their management teams can play a more passive role, so the fees involved in investing in index ETFs are relatively low. Depending on your personality as an investor, though, there are a bunch of other options that fall under the ETF umbrella, including actively managed funds designed to produce returns above index benchmarks, dividend-yielding ETFs, and those that pursue specific trading strategies like trend following.

What is a mutual fund?

A mutual fund has the same underlying premise as an ETF. The fund uses investors’ funds to invest in various securities; this increased buying power comes with advantages like easier diversification and the ability to buy high-ticket investments like real estate outright. Investors buy and sell “units” of the fund instead of shares but can only do so once per day, after the markets have closed. 

Mutual funds have traditionally been actively managed with the stated goal of beating a benchmark index. Because this means higher overhead costs, investors can expect to pay higher fees, offset by the possibility of returns above the market average. However, the trend of the mutual fund industry is shifting towards tracker funds, also known as index funds. Pension contributions are often stored and grown in mutual funds, and these can make up a large portion of certain funds’ Assets Under Management (AUM).

The similarities between ETFs and mutual funds

Less risky than individual stocks

This is the big one. Without doing any deep research or going to extra effort, investors can simply place their money into tens or hundreds of different securities organised into a balanced portfolio. Even if one stock performs badly or one bond defaults, you won’t lose the farm.

Lots of choice

There is a plethora of different ETFs and mutual funds to choose from. For example, you can opt for a broad and very diversified investment in blue-chip stocks, or put your money in a fund focused on a specific sector or country.

Professionally managed

If you don’t have the time or inclination to make your own investment decisions, ETFs and mutual funds offer a cost-effective way to get a professional to manage your investments for you. For most of us, their expertise is very much worth the higher fees.

Lower trading costs

Buying a share in an ETF or a unit of a mutual fund does involve paying transaction fees, but these are typically much less than the aggregate cost of all the individual investments you would need to replicate what’s in the fund. If you wanted to track the S&P 500, for instance, you’d need to buy hundreds of different stocks, and that would involve a lot of commission.

The differences between ETFs and Mutual funds

When comparing ETFs vs mutual funds, these are the differences that matter most:

Minimum investment and reinvestment options

The smallest amount you can invest in an ETF is simply the price of one share of that ETF. For example, if the ETF has a market price of $50, the minimum investment is $50. Mutual funds have a set minimum amount needed to invest in the fund, which is typically about $1000-$5000. The minimum investment is unrelated to the total value of the fund.

You can buy new shares of an ETF at any time, and online trading platforms allow you to arrange regular payments from your account to buy more shares. Automatic reinvestments can be agreed directly with the mutual fund, and this can usually be done directly from your salary if you invest via a pension plan.

Which is the right choice for you?

Choosing between ETFs vs mutual funds ultimately comes down to which structure fits your goals and the assets you want to hold.
Remember that, although the above points are all important considerations for which investment to make, they aren’t enough to determine your final decision.

Before you make a hard choice as to whether an ETF or mutual fund suits you best, you have to consider the securities that are in each individual fund. The differences in this regard outweigh those between the two types of fund, so check carefully whether they match your investment goals and the asset mix you are trying to achieve. 

The first things to look at, of course, are the fund’s fee structure and track record. Besides that, there is no shortage of choice when it comes to the ETFs and mutual funds offered by the major asset management companies. Unless your requirements are extremely specific, you can usually find the ideal combination of instruments you want to invest in in either fund type. The investment philosophy and strategy each follows is spelt out in detail in its prospectus, available on the managing firm’s website, and it’s worth reviewing this in detail.

Consider ESG factors and niche sectors

Some funds offer global diversification, providing you with some measure of safety in an uncertain world. Others make a point of taking ESG (Environmental, Social, and Governance) issues into account and are arguably a more ethical way to invest. Even if you are determined to invest in a niche area, like Chinese electric vehicle manufacturers, you can probably find either an ETF or a mutual fund that has a lot of these assets under management, though it may not be under the control of the most reputable investment company.

This abundance of choice can seem a little overwhelming. Whether you end up going with either an ETF or a mutual fund, though, you’ll actually have removed a lot of the complexity associated with picking more atomised investments. Once you’ve made your decision, you will not have to trouble yourself with picking individual stocks, fundamental analysis, or risk management, and this time saving makes either kind of fund worth having.