ETFs Vs Mutual Funds — Which Is Better?

Check out this complete guide to learn more about the differences between mutual funds and ETFs and determine which is better for your needs.

Updated: January 15, 2024
Matt Crabtree

Written By

Matt Crabtree

|
Jason Mountford

Edited By

Jason Mountford

 

ETFs and mutual funds are investment vehicles that work similarly, but also have some differences too. These two different types of funds have unique qualities that set them apart when it comes to investing options. 

So, how do you choose which one you want in your portfolio? Well, it depends. It’s important to understand and be able to distinguish the differences so you can choose what will work best for you.

What Is an ETF?

An ETF is an exchange traded fund. An ETF is a compilation of assets that are put together to work towards the specific goals of the ETF. In most cases, ETFs track against a specific index, but not always.

You can find ETFs that vary in strategy or are focused on specific areas of the market, such as real estate, growth, income, etc. 

An ETF trades just like a stock does, which is one characteristic that makes them different from mutual funds. You can find ETFs on any exchange that they are compatible with. Different exchanges will have different ETFs to choose from. 

When you purchase ETFs, you purchase them at the market price and you will generally pay an upfront fee or commission. 

What Is a Mutual Fund?

Mutual funds are also a pool of funds, and there are a lot of great mutual funds out there to choose from. These funds can hold anywhere from 20 to 30 assets, to thousands of assets. How much they hold inside of them simply depends on the strategies and the management of the fund in question. 

Some mutual funds require higher investments to get into, but there are many funds out there that you can invest in for as little as £1. Some mutual funds have limited availability, while others are open-ended and will take as many investors as want to jump in. 

Mutual funds are typically sold by amount rather than by share. They can also be purchased in fractional units, which is unusual for stocks or ETFs. Just like ETFs, there are several different types of mutual funds to choose from.

You can select funds that fit your strategy needs and goals, including growth, income, or certain market types such as real estate or large companies and more. 

How Are ETFs and Mutual Funds Alike?

Right away, you notice some similarities between these two assets. Both types of assets are a compilation of marketable investments that are pooled together to create the fund of choice. Mutual funds and ETFs both can have any number of assets within them, and those assets are all determined and held based on the strategy of the fund. 

The structure between the two is very similar, which means your exposure is also very similar.

Both of these types of holdings will provide you a broad exposure to the markets, typically within a specified niche. Both of these investments also have multiple choices so you can pick what works best for you. Those choices might fall into some of these categories. 

You can find mutual funds and ETFs that fall into just about any investment strategy. There will be options that are conservative and options that are high risk on both sides. And yet, you also have diversity within any single fund from either ETFs or mutual funds, which is pretty cool. 

How Are ETFs and Mutual Funds Different?

While these two investment instruments have a lot of similarities, they also have some differences to note. Both ETFs and Investments have tons of options on the market. You can find anything to meet your strategies in either category. And while their structures are very similar, that’s primarily where the similarities end. 

ETFs are traded on the exchange and the order to buy or sell is executed at the market price at that moment. However, mutual funds are not on an exchange and they are traded at the end of the market day, for whatever price the market closes at. Every purchaser of a specific mutual fund on a given day will pay the same price that day for their fund investments. 

Management style can also be different, but similar in the same regard. Mutual funds have both active and passive management for their funds. Because ETFs tend to favour passive investing strategies, on average, ETFs charge lower ongoing fees than mutual funds.

Active management means there may be frequent changes and trading within the fund and it’s constantly monitored and adjusted for the intent of the fund. 

Passive management means that they set it and forget it. The majority of ETFs are passive and set up to match a specific index or benchmark. Because ETFs tend to favour passive investing strategies, on average, ETFs charge lower ongoing fees than mutual funds. There are some actively managed ETFs out there, but they are more rare in this particular asset. 

Minimum investments can vary by each of these, too. ETFs don’t necessarily have a minimum, but you will need to be able to purchase a full share, so your minimum investment is the price of a full share. Mutual funds, however, are usually traded in specific amounts, rather than shares.

Most mutual funds have a set minimum investment, and some of them are pretty high too. However, mutual funds can be purchased in fractional shares as long as you meet the minimum. 

ETFs and Mutual Funds definitely vary when it comes to costs. Both instruments are going to be profitable for the managing company, the costs are just faced in a different way.

Since an ETF trades like a stock, you typically are going to pay a fee or commission when you buy or sell your shares of this ETF. 

Both mutual funds and ETFs have ongoing expenses that can vary depending on whether this is an active or passive fund. Mutual funds don’t typically charge a commission when you purchase the investment, but you will pay an ongoing expense for holding the fund, which are like operating expenses of the fund.

Sometimes, you do have to pay sales loads or redemption fees, depending on the mutual fund. 

Finally, the tax repercussions might also make a difference in your decision. ETFs and mutual funds have different tax structure and implications.

The main tax difference between and ETF and a mutual fund is that an investor will only pay capital gains tax when they sell their holdings. Mutual fund investors, on the other hand, may need to pay CGT if the fund manager has realised gains within the fund during the year.

In summary, this is where mutual funds and ETFs show major differences. 

  • Expense ratios/costs
  • Taxation
  • Minimum investment vs share prices
  • Trading style
  • Management style

Who Are ETFs Best for?

Choosing to invest in ETFs could be a good fit for just about anyone. If you are an active trader that wants the ability to place limit orders or even short sell, then an ETF allows you that possibility. They are a good fit for active trading because of the flexibility and the ability to sell them at a specific price any time of day in the market

In addition, ETFs might be better for someone who is worried about capital gain consequences or has more tax sensitivity with their investment selections. ETFs give investors more control over their tax position. 

Who Are Mutual Funds Best for?

Just like ETFs, mutual funds can be a great fit for a lot of investors. In fact, some people choose to hold both types of assets, and that’s perfectly acceptable. Mutual funds are great for beginner investors as they give you a broad exposure to the market in a single fund.

As long as you can make the minimum investment, you can get in for cheap, and that’s a major benefit. 

If you want to have the ability to reinvest or add to the same fund frequently, a mutual fund is a great choice to do so, especially if you choose a no-load fund that won’t charge upfront fees for your regular investments. Even if your investment amounts are small, this will add up over time. 

Mutual funds always trade at their net asset value, which means you always know what you’re paying and what you get for your purchase price. You can’t limit order or stop sell, but they are simple and easy to use and understand.

Choose What Meets Your Needs

While we could certainly pick apart the differences and tell you what is best in certain areas, we can’t determine what is the best fit for you. As an investor, you likely have goals and even limitations when it comes to investing. You know what your needs are and you even know where your preferences lie. 

Instead of trying to determine whether ETFs or mutual funds are better than the other, try to pinpoint which one will be the best fit for your investment needs. Both have their own advantages and disadvantages, so once you understand those, you can determine which one will work for you! 

Final Thoughts

ETFs and Mutual Funds have a lot in common, but they also have some major differences. Neither investment is a bad investment, and which one is the right fit will depend on your goals and what you hope to accomplish with your trading practices.

Take the time to learn the differences and figure out which is the best fit for your portfolio. You might even decide that you want to hold some of both! 

These investment instruments are known for their diversity in purchasing just one fund. They are both a pool of assets designed to give you broad exposure to a specific area of the market. They do operate differently, but either one can be a great choice.

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