Weighing out the pros and cons of ETF and mutual funds

If even the mere mention of terms like mutual funds or ETFs makes you scratch your head, do not despair. You are certainly not alone and we all have been there. The good news is that they are not as complicated as you may think, and like anything in life, it takes time and effort to truly understand and appreciate these investment concepts through careful research. Nowadays, you wouldn’t even buy a cell phone without some good old-fashioned research, right? The same goes for your investments.

In this blog, I will be going over the main differences and similarities between mutual funds and ETFs (exchange-traded funds) because while they are both investment vehicles, there are a few distinguishable characteristics that I will touch upon here. Both share the same structure in the sense that they own stocks, bonds, and other types of financial securities. Each mutual fund or ETF has a different investment style & objective and comes in many varieties. With that said, we will dive headfirst into some details and show you how you can approach adding them to your portfolio.

Mutual funds

Here is a quick historical fact: In 1924, Edward G. Leffler launched the Massachusetts Investors Trust, the first mutual fund. Before this, investors who wanted a diversified investment portfolio had to buy shares of individual stocks or bonds, resulting in expensive commissions. This was the first way to efficiently invest in multiple securities without having to purchase them directly. By definition, a mutual fund is an investment tool, comprised of money collected from investors for the purposes of investing in securities such as stocks, bonds, money market instruments, and other assets.

Actively managed mutual funds are usually managed by a team of investment professionals that typically consists of portfolio managers and researchers whose end goal is to scope out the best opportunities in the markets so the mutual fund can outperform its assigned benchmark. Professional management of the fund is important mainly because investing your hard-earned money in the right place requires a lot of research and knowledge to study and analyze the financial markets. Professional portfolio managers have extensive experience under their belts and the ability to constantly monitor the markets to pick the right investment strategy compatible with your risk/return profile, meaning you can relax knowing that your money is in safe hands. NAV, net asset value, is determined based on the value of securities contained in the portfolio and represents the price of each share of the mutual fund that is calculated at the end of each business day. Diversification is one of the key advantages of mutual funds over other investment options because your money is invested across multiple markets such as money markets, equities, and bonds, and the decline of one market gets offset by an increase in another thus increasing your chances of earning good profit and recovering overall losses of the mutual fund. Liquidity and being accessible to small investors are other important factors to consider mutual funds in your portfolio while acquiring a good understanding of the expense ratio associated with running actively managed mutual funds. Simply put, an expense ratio is the percentage of a fund’s assets that go purely to running the fund that encompasses various costs including the management fee. The cost factor should be carefully investigated and understood before making any investments. These costs must be transparently disclosed in the mutual fund’s prospectus, which you can download directly from the fund company’s website or mutual funds research websites such as Vanguard or Morningstar. Fees along with the lock-in clause imposed by some mutual funds could be disadvantages – make sure you ask your Financial Advisor about these points upfront.

Mutual funds play an increasingly important role in financial markets today, with the number of open-end funds worldwide increasing by nearly 40 percent from 2011 to 2019. In terms of the regional distribution of mutual fund assets, almost half are concentrated in the United States alone. As of March 2021, Blackrock Funds was the world’s largest mutual fund company, with around 9 trillion U.S. dollars of assets under management. Rounding out the top three were Vanguard with 7.2 trillion U.S. dollars of AUM, and Charles Schwab with 7.07 trillion U.S. dollars of AUM.

_{(Source: Statista)}

ETFs (Exchange-traded funds)

Exchange-traded funds, ETFs, on the other hand, are passive investment vehicles that trade on stock exchanges like a stock and instead of buying ownership of one stock, you buy an ETF that is formulated to track and match the performance of a particular market index. The first ETF was created in 1990 in Canada and three years later the Securities and Exchange Commission approved the first ETF in the U.S.

You may be surprised to know that ETFs and mutual funds share similar characteristics, but there are a few key differences that set them apart. One key difference lies in how they trade, traditional mutual funds, whether actively managed or index funds, can only be bought/sold once daily whereas ETFs throughout the day just like stocks, meaning investors can react to news faster in buying/selling ETFs. In terms of performance, as mentioned above, actively managed mutual funds have a team of experts choosing exactly how to invest your money wisely and can rearrange the holdings in volatile markets to avoid big losses. ETFs have little flexibility in the sense that if the index does well so does your holdings and vice versa. Another key difference would be transparency. Most mutual funds disclose their holdings on a quarterly basis while, in contrast, investors can view a typical ETF’s holdings online any time they want. Finally, ETFs are not cheaper, but they can be more cost-effective for an average investor than any other fund, unless a broker charges you fees when you buy or sell ETF shares: then the cost-effectiveness can go down the drain. ETFs can track indexes from bonds to the NASDAQ, so be sure to choose the one that represents your risk-tolerance and long-term plan and one that has been around with a solid track record and with higher dividend yields.

To illustrate the massive size of the industry, today the value of assets managed by exchange-traded funds globally stands at 7.74 Trillion USD with over 7,600 ETFs worldwide. In the US, SPDR S&P500 is the largest in the world with a market capitalization of 327.3 Billion USD.

_{(Source: Statista)}

There is no one-size-fits-all kind of solution when it comes to your investments. Given the abundance of funds and ETFs available to you, picking the right one will depend on several considerations such as your investment horizon, risk tolerance, and financial goals. Always speak with your Financial Advisor and ask those crucial questions to identify what’s suitable for you and stick to what you know. Happy Investing!

_{Disclaimer: This article has been distributed for educational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy, or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.}