I’m going to compare ETFs to mutual funds today in a very basic way to try to help our new investors out. I will keep it simple today and not get into too many details about the different kinds of mutual funds and ETS, but rather give investors a very high level of understanding of each and the pros and cons.
I started following the start market about 30 years ago. Back then, you didn’t have many options and could only choose between going to a stock broker that would put you into stocks and bonds or purchasing a mutual fund. Both are still good options for investing, but ETFs have really changed the game.
Most people must save money a little at a time and start investing small amounts. Today, some of the popular stocks like Amazon or Google are thousands of dollars for one share. Both mutual funds and ETFs allow investors to invest in the stock market and diversify their investments by buying many stocks with one investment share.
Sound confusing? Both mutual funds and ETFs both are baskets of stocks. They can also include other investment products, such as cash, bonds, and options. For the most part, you’re looking at investing in a basket of different stocks. You’re buying a fractional share of different stocks and bonds by buying either a mutual fund or ETF. This allows investors to buy all S&P 500 stock shares without having to buy each stock individually and at a lower cost.
You might be asking, “Why not just buy the stocks?” The answer is you certainly can.
However, you may have enough money to purchase all the stock or all the stock you want. Take Amazon stock (NASDAQ: AMZN). It is currently trading at $2,132 a share! That is out of the budget for most people.
Also, it would be best if you diversified your investments. This means spreading your risks out so that if one stock goes down, your investment portfolio as a whole only goes down a little.
What is the difference between a Mutual Fund and ETF?
The most significant difference between a mutual fund and an ETF is that mutual funds are typically more actively managed. ETFs generally are set up to follow specific market indexes, like the S&P 500.
However, mutual funds usually have a higher cost than EFTs because they have people/money managers that are actively managing the fund.
In addition, Mutual funds have different share classes that vary in fees. ETFs have only internal fees.
According to Morningstar, the average ETF carries an expense ratio of 0.44% compared to a mutual fund of 0.74%. This means the ETF stock will cost you $4.40 in annual fees for every $1,000 you invest or $7.40 for the mutual fund.
Mutual funds also have many more different investment objectives. You will find some that have an income objective, while others may be focused on growth.
Lastly, mutual funds are usually purchased through the companies themselves, while ETFs are bought and sold on exchanges like stocks.
Is A Mutual Fund Better Than an ETF?
It is just a matter of opinion of which one is better. Some investment gurus swear by mutual funds, while others point to buying index funds.
I should point out that ETFs typically have a better tax structure than mutual funds because they are bought and sold on exchanges.
Comparing them on an investment return (ROI) basis is very tough because mutual funds often cover many different sectors and have different investment objectives.
Investors should take the time to consider all their options before they start. There are thousands of mutual funds and ETFs to choose from. An excellent way to start comparing the pros and cons would be by looking at the performance and costs.
Most online brokers offer free tools for researching investments. You can also use Morningstar, Finviz, or Yahoo Finance.
Recently I started using M1 Finance. They have free trading and great tools. Using their app, you can easily select a pie that meets your investment needs.