These two terms are often thrown around interchangeably, but what is the difference between them? Most brokerages, like Vanguard, offer the same underlying assets as both mutual funds and ETFs – so which one is best for you?
Mutual Fund and ETF Similarities
Before going into the differences, let’s review the similarities.
- Both allow you to invest in a single fund that then invests in a bunch of funds (diversification).
- Both will have a management fee (expense ratio) that you pay to hold the fund. This fee isn’t paid directly but does affect the price of the fund (fee).
- Both will shift their underlying assets to keep them up to date with the index (turnover).
- Both will (most likely) give of dividends which you’ll be taxed on. (dividends).
- Selling either will result in a taxable event which could result in you needing to pay taxes (tax).
The last two, dividends and tax, would also apply to company stocks as well. For funds that provide both a mutual fund version and an ETF version, the above 5 criteria will be identical – except the amount of the fee, which will likely be different.
How Mutual Funds and ETFs Are Different
Vanguard actually has a great introduction to this on their site, but I’m going to be using that as a starting point, but I’ll be expanding it beyond Vanguard and digging in a little deeper with some personal opinions on why you should use one or the other.
|Buying & Selling||Available across brokerages. You can buy a Vanguard ETF from a Fidelity account, or vice-versa.||Only available at the issuing brokerage. ex: Vanguard mutual funds are only available at Vanguard, Fidelity mutual funds at Fidelity, etc.||ETFs are more widely available. But if you just want one account (as I do), then Mutual Funds.|
|Trading & Pricing||ETFs trade on the open market and their price changes throughout the day. You can buy/sell them at any time during the day at the current price.||Are priced at the end of the day only. Anytime you buy/sell/trade shares, the transaction won't execute until the market closes and the fund is priced for the day.||Mutual Funds forgo the hassle of worrying about specific share prices.|
|Transaction Costs||Depends on the brokerage. Vanguard allows trading Vanguard ETFs for free, but if you buy a Vanguard ETF from a Fidelity account, you may have to pay a small trade fee (like when buying stocks).
There is another cost called the "bid-ask" spread - the difference in how much you want to pay and how much someone will sell for.
|Unless the fund is a load fund, has a purchase fee or a redemption fee, there will be no transaction cost. (if it has one of these fees, I recommend not buying it).||Mutual Funds win big here by having no fees when bought from the issuer.|
|Automatic Investing||Depends on your brokerage. 401ks will generally allow automatic investing in ETFs, but most brokerage accounts won't. Vanguard, for example, does not allow automatic investing in Vanguard ETFs.||Most brokerages allow automatic investing into mutual funds.||ETFs win for 401ks, but Mutual Funds funds win overall.|
|Minimal Investment||You can buy as little of an ETF as you want, but it'll need to be in whole numbers. Because of this, your investment amount needs to be divisible by the price.||This threshold is usually on a fund by fund basis. Most Vanguard funds have a minimum threshold of $3,000 to start the account. After that you can put in as little as you like (for free) as often as you like.||ETFs have a much lower minimal investment.|
|Fees||Generally have the lowest fees.||For Vanguard, mutual funds have "Investor" and "Admiral" shares. Investor share fees are higher, while "Admiral" shares tend to be about the same as ETFs.||ETFs have lower fees overall. If you have enough money to buy Vanguard Admiral shares, fees will be similar.|
|Winner||2||4||For ease of investing: Mutual Funds. For control: ETFs.|
My pick for investing are mutual funds. They offer more advantages and fewer chances for something to wrong than with ETFs. Once you have enough to upgrade from Vanguards Investor Shares funds to Admiral Shares, the fees are equivalent as well. Before that, it’s around a 0.1% difference (not insignificant, but does usually go away once you hit $10,000 in a fund).
One concept that’s glossed over in the above article is the “bid-ask spread”. If you’ve ever bought or sold stocks, you’ll be familiar with this concept. The idea is that when you’re buying or selling funds, there isn’t a set price for them. There’s what you offer to buy them for (your bid), and how much people are willing to sell them for (their ask). The price of a fund rises when people start buying the low “asks”, causing the new lowest ask to be higher.
With ETFs and stocks, this results in ever-fluctuating prices. Depending on your brokerage, there may even be an additional cost to place a “limit order” – a type of trade where you give a maximum “bid” so that if the “ask” prices change too fast, you don’t end up chasing it beyond your intended range. When buying mutual funds you don’t need to know about bid, ask, limit, market or stop-limit type orders, making them significantly easier for the average, or minimal investor.
Less Control as a Feature
I’m generally one who wants as much control as possible — especially when money is on the line. What I came to realize was that having the ability to invest anytime during the day was a lever of control that was doing me more harm than good. I’m not watching the markets every day to know when it’s best to invest, so choosing an ETF and saying “it’s 1:45pm on a Tuesday and the market just went down 0.4% – buy buy buy!” wasn’t what I wanted to do.
Instead, Mutual Funds are priced at the end of the day, and I know it’ll be stable for the rest. I’ve bought funds on dips before (thinking I was all smart) only to have them immediately fall further. With Mutual Funds, it’s just less to worry about. You put in a trade order, and it executes during that long stretch of time between 4pm and 8am the next day.
What I Use
In my 401k account, I use only ETFs, but that’s all that’s offered there. Within my Vanguard account, everything is a mutual fund — aside from a few legacy shares of Apple and Tesla.
Do you prefer to own ETFs or mutual funds? Is there something I haven’t considered about ETFs that makes them more attractive?
1 CommentWhy not add to the conversation below? Your voice is welcome!
November 3, 2017
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