Investing > ETF vs. Mutual Fund: Compared

ETF vs. Mutual Fund: Compared

ETFs and mutual funds are both great options for long-term investing, but how do you know which one is better?

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Updated March 11, 2022

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Want to make some money but scared to risk it all? 💰

Well with ETFs and mutual funds, you won’t have to. Well, you’ll still have to invest some money, but the risk is much lower than walking into the casino and putting your entire net worth on red. Except you won’t be getting any free drinks when you invest in ETFs or mutual funds, unfortunately. 

Regardless of the lack of free drinks, ETFs and mutual funds are both great options when you want to diversify your portfolio but worry about exposing yourself to too much risk. Despite what you may think, ETFs and mutual funds are not equal. They both have unique pros and cons that can make one work in your investment portfolio while the other does not. 

But no matter how you look at it, ETFs and mutual funds are equally easy to invest in and provide their investors’ exposure to a wide range of companies with a single purchase. The differences only really come into play when it’s time to cash out of your investment or when tax season rolls around. 

However, when it comes to deciding on your investments, picking something with fewer tax burdens or ease of cashing out isn’t everything. Just take a look at how one mutual fund manager, Scott Weber, is taking the world by storm and making lots of returns for those invested in his portfolio. This is just one of many examples of how one type of investment can outperform another.

This is why it is so important to know all the facts before you get involved in either investment. Keep reading to find out more about ETFs, mutual funds, and which one is ultimately better for you to invest in. 

What you’ll learn
  • How are ETFs and Mutual Funds Different?
  • Types of Management
  • Fees Compared
  • Minimum Investment
  • How Easy are They to Trade?
  • Taxes Explained
  • Which Has Better Performance?
  • Dividends
  • Conclusion
  • Get Started with a Broker

How Are ETFs and Mutual Funds Different?

Before diving into the differences between these two investment types, it’s important to know what they are. 

An ETF is an Exchange-Traded Fund, and it is when an exchange will take a collection of companies of a certain type of commodity, put them together in an index, and allow investors to invest in them all with a single purchase. For example, a healthcare ETF would be a collection of several different companies together like Pfizer, United Healthcare Group, and Teladoc Health. 

Meanwhile, a mutual fund is a collection, or pool, of funds from a group of people that are invested in a portfolio that contains a variety of investments grouped together. This group of investments is managed by a fund manager who makes changes to the allocation of the money in the fund in order to try and reach a monetary goal. 

FeaturesETFsMutual Funds
Diversified HoldingsYesYes
Traded on ExchangeYesNo
Intraday TradingYesNo
Expense RatiosUsually LowerUsually Higher
Dividend PaymentsUsually Distributed to InvestorsMay be Automatically Reinvested
ManagementGenerally PassiveGenerally Active
Fees0.44% on Average0.5% t0 1% on Average
Minimum Investment RequirementsUsually LowerUsually Higher

Both ETFs and mutual funds can be built around almost any sort of commodity, from bonds to gold or even based on an index of the top 500 companies. They are both excellent long-term investments with less risk than going all-in on one company. 

Although these may sound very similar, there are actually quite a few differences between the two, namely when it comes to the management of the fund. Mutual funds are actively managed, while ETFs are passively managed, and this creates a world of difference when it comes to your ability to invest, the fees required, as well as the taxes you will pay on your capital gains

ETFs vs. Mutual Funds: Types of Management

As mentioned above, the biggest difference between ETFs and mutual funds is their form of management. ETFs typically do not have an active manager while mutual funds have a manager or a group of managers that are involved in deciding the holdings of the fund on a daily basis. 

But not all mutual funds are managed the same. It’s important to know how a mutual fund you are planning to invest in is managed, as this will dictate the direction of your investment as well as some of the fees you can expect to pay along the way. Additionally, there are some ETFs on the market that are actively managed, and it is important to pay attention to this so you know what to expect when you invest. 

Top-Down Management 👔

When investing in a fund with a top-down management approach, this means that the fund manager, or group of managers, will be looking at the economy as a whole and calculating which sectors will benefit from a better economy. They then invest in these companies. This investment style doesn’t require a ton of time to be taken looking into individual companies.

Bottom-Up Management 🔝

This is the opposite of the top-down approach. Instead of looking at sectors, then companies that will benefit, the bottom-up approach focuses solely on certain companies. For example, you could join a mutual fund that was focused heavily on the company Tesla and buying its stock regardless of the economic climate. 

This type of management typically takes a lot of time, as the company invested in will be heavily researched to be sure it matches the needs of the fund. In the above example, a company like Tesla was probably chosen because they have a high rate of return, high dividends, or low debt to income ratio, among many, many other things. 

Blend of Management Styles ↕️

Most mutual funds are managed on a combination of the above management styles, and this is known as blend management. This means that the fund managers typically look at top-down management first, then once they find a sector, they use the bottom-up style. This, of course, requires a more time-consuming (and thus more expensive) approach. 

Spread Trader 💲

This type of management is typically only found in fixed-income mutual funds, but the purpose of this type of management is to trade commodities without increasing the risk of the fund as a whole. 

This is usually done by solely trading bonds and other low-risk commodities. This takes a lot of research to be able to know when the bonds should be traded and for what other bonds.  

Interest Rate Anticipator ✅

This is another type of management style for fixed income mutual funds, and like the spread trader, this type of management typically only trades bonds. The difference is, an interest rate anticipator will trade bonds when they believe the government’s interest rates will change. This is considered slightly riskier than spread trading, and also takes a significant amount of research. 

Better Fees: ETFs or Mutual Funds? 💸

You may be wondering why you should care about the investment style of your mutual fund. And this is because the type of investment style your fund requires will dictate the type and amount of fees you will pay. 

ETFs, because they have a passive management style, typically have little to no fees. Fees for passively managed funds can start as low as 0.03% and should extend up to no higher than 0.2%. Obviously, there will be some with higher fees, but at that point, you should consider an actively managed fund rather than a passively managed one. 

Mutual funds, on the other hand, have higher fees to pay the person or persons that are actively managing them. They also typically have fees for buying and trading the mutual fund shares. The annual fees for a mutual fund usually start at 0.25% and can extend all the way up to 1.5%, while the fees for buying and selling the fund can be anywhere from 2-5%. And recently, some platforms have even announced that they will be raising their fees for purchasing certain mutual funds

Although these may seem low, they really can add up over time. This is why you have to pay careful attention to any fees an investment may incur. Take a look at the chart below. 

average ETF returns
Even though individual ETFs vastly outperform the markets, as a whole, the average ETF returns are far lower than that of the S&P 500. Image by TradingView.

As you can see, although the funds grow by the same amount for the first 15-17 years, by the time the 19th year comes around, the fees are weighing heavily on the MER mutual fund, while those who chose to invest in the MER ETF are netting much more in returns from their initial investment. 

And you can see this come into play when you take a look at Vanguard’s Energy ETF, which has an expense ratio of 0.10%, while their equivalent energy mutual fund has an expense ratio of 0.33%. This isn’t as high as some mutual funds get, but it is still over three times higher than their energy ETF which invests in similar companies. 

ETFs and Mutual Funds: Minimum Investment 🔎

Do you have $5000 lying around that you want to get rid of?

Yeah, us neither. Something that hasn’t been discussed yet that also should play into your choice when deciding between a mutual fund is the requirement of an initial investment. 

Generally, when purchasing ETFs, there is no minimum investment as long as you are able to afford one share. Different ETFs have different share prices, and although some cost in the hundreds of dollars, you can definitely invest in an ETF for as little as $60-$70. 

Mutual funds, on the other hand, can have a fairly high initial capital requirement when you invest in them. And while this initial investment is often based on the goal of the fund, don’t be surprised when you find out that the initial investment can typically top $1,000. For the Vanguard Energy mutual fund mentioned above, the initial investment required is $3,000. 

But before you toss mutual funds aside, be aware that many people get involved with mutual funds through an employer-sponsored investment program. And in this case, the minimum investment can often be waived or non-existent. And employer matching (if your job does this!) can actually make a job-sponsored mutual fund more worthwhile than investing your money on your own in ETFs. 

How Easy Are ETFs and Mutual Funds to Trade? 🤝

Another aspect of ETF and mutual funds that you have to consider is how easy they are to trade. Generally, they are both best left as long-term investments, but if you do need or want to trade them at any point, you need to be aware of how difficult it may be. 

ETFs are priced based on market conditions, meaning the price will fluctuate all day long. This also means that you can buy and sell ETFs at any point during the trading day. And so you long as you opt for one of the top ETF brokers out there, these trades will be a little or no cost to you as long as you are buying the ETFs sponsored by the broker.

There is also no minimum holding period when you are trading ETFs. So if you buy a few shares one day but decide you want to sell them the next, there is no penalty for doing so. This makes it easier to adjust your portfolio over the years as you see fit. 

Mutual funds can, unfortunately, only be traded at the end of the day. And if you put your trade in after a certain time, it will not execute until the next day. This is because the company that manages the fund only calculates its value once per day rather than constantly like ETFs. 

ETF_vs._Mutual_Funds icon
Both types of funds consist of a mix of many different assets and represent a common way for investors to diversify.

For example, on Vanguard, you must place your mutual fund trades before 4pm EST time, otherwise your trade will execute the next business day. This means no trading on Saturdays or Sundays. 

Selling mutual fund shares isn’t easy as some funds require that they find a buyer before they allow you to sell. Additionally, you should expect there to be a penalty if you sell too soon after buying, typically less than 90 days. This means that mutual funds are not a good idea for day traders and are rather a choice solely for long-term investment. 

Taxation with Mutual Funds and ETFs 💵

Now it’s time to talk about everyone’s favorite thing, paying taxes. 💀

As if investing couldn’t get any more complicated, you also need to take a look at the taxes you can expect to owe from your investments before you commit to investing. And the taxes vary widely between ETFs and mutual funds. 

When you buy an ETF, you will owe no taxes until that same share is sold, at which time you will owe capital gains taxes. This is because there is no active day-to-day trading within an ETF. And for those that can’t stand paying taxes, many professionals will advise you towards ETFs because they really are the more tax-friendly investment option between the two. 

When it comes to mutual funds, they are actively traded, and there are a lot of stocks and commodities being switched out on a day-to-day basis. This means that you could owe capital gains taxes on your mutual funds even before you have sold them. And these taxes are shared among everyone in the mutual fund. 

Which Has Better Performance? 🤲

And now, for the question of the hour, it’s critical to know whether ETFs or mutual funds perform better, and we aren’t talking about a hotdog eating contest. 

How ETFs and mutual funds perform moneywise is one of the most critical parts in your decision-making process. And there is, unfortunately, no easy answer (as there would be to who won the aforementioned hotdog eating contest)

Both mutual funds and ETFs have combinations of the same assets, and this means that they can both perform the same. And because they perform in very similar fashions, this is what makes the fee structure mentioned above so important. Basically, if you are about to make the same money either way, but one way will take a larger percentage of your profit, why would you pick it?

We aren’t the only ones to come to this conclusion, and in the past decade, there has been a massive shift from mutual funds to ETFs. This is because ETFs are an easier, lower fee way to get the same returns, and after the financial crash of 2008, they didn’t suffer nearly as much damage. This made investors realize that they really could gain a similar amount of money without having to put in all the work or share their profits. 

The multitude of ETF types makes this investment category suitable for most investors.

To give you an idea of what this looks like, take another look at the two competing Vanguard Energy investments mentioned earlier. In October 2021, the ETF has had a YTD return of 29%, while the mutual fund has only had a year to date return of 25%. And remember you are paying 3 times the fees when you invest in the mutual fund. 

And this doesn’t just happen when you look at the energy company based funds, in fact the same thing happened in the silver industry, the ETF outperformed everything else—without all the risk that comes with investing in something else. 

Of course, there are some mutual funds that far outperform an ETF investment, such as the one run by Scott Weber, and this is because sometimes fund managers are able to predict certain weaknesses in the economy or possible bear markets, and change the investment strategy of the fund to avoid them. 

Remember that an ETF investment will be unlikely to outperform the average stock market return. And that there is a chance that an ETF can do poorly for no reason that anyone can predict. For instance, Black Rock has had a particularly rough year in this regard, as their ETFs have lost money while others have flourished. 

But you also need to keep in mind that because these funds are actively managed by humans, it’s hard to know if you will pick the correct fund that will outperform an equivalent ETF investment as humans can make research errors. This means that you cannot count on your mutual fund investment outperforming the stock market. 

Dividends Explained 🏦

Maybe you are here because you are interested in earning dividends over the course of your long-term investment path. In this case, it is important to know whether ETFs or mutual funds will net you more dividends. 

While there are some ETFs that will earn you dividends, be aware that you might have to shop specifically for these ETFs. For example, Vanguard has a High Dividend Yield ETF which is, obviously, an index of companies that return dividends. But this isn’t always the case, so you may need to look around a bit on the platform of your particular broker if you are really interested in earning some dividends on your investment. 

Mutual funds actually work in a similar function. Because they are actively managed, and the asset selection is made by a manager, this means if you want dividends, you should join a mutual fund that specifies they are trying to find dividends for their investors. This will ensure that your money is allocated to where it will make you the most dividends. 

Be careful when searching for dividend-earning mutual funds, however, because this can change the taxes you may owe at the end of each year, or when you cash out of the fund—or both. 

Mutual Fund vs. ETF: Which is Better For You?

Time to conquer the real question, just how do you pick between an investment in ETFs or mutual funds? The truth is, the answer to this question will widely depend on you and your preferred investment style.

If you prefer to purchase investments, leaving them for the long term, then you may want to look into a mutual fund. This is because the sales fees and restrictions on trading these funds won’t bother you. Plus, with a mutual fund, you will have someone actively trading your investments as the market changes, giving your money the chance to outperform the market. But if you don’t have a lot of capital, mutual funds are typically out. 

For those with a low amount of capital available to start investing or who think they may want to change their investment along the way, ETFs truly are the better option. Not to mention that over the long run, if a mutual fund and ETF perform the same, you will likely lose less of your profit to fees than you would in a mutual fund. And the taxes are easier for someone newer to the market to handle. 

But remember, there are pros and cons to each investment, so be sure you think it over long and hard before deciding where to put your hard-earned money. You never know just when you might choose a profitable mutual fund or ETF. 

Conclusion 🏁

Both ETFs and mutual funds are a great way to invest your money for the long term. Although they function in similar manners, there are still many differences that set them apart. And the main difference is the management style.

This difference in management style affects everything from the fees you will pay while in the fund, as well as the taxes you will pay when you sell. Because of this, it is imperative that an investor research both options, as well as their particular investment, before investing. But no matter which you decide to go with, an ETF or a mutual fund, either is an excellent way to diversify a portfolio. 

Mutual Funds vs. ETFs: FAQs

  • Are ETFs Safer Than Mutual Funds?

    ETFs and mutual funds are both made up of a mix of assets, meaning they are both lower-risk investments. But if you consider the human involvement, ETFs may be considered slightly safer than mutual funds. 

  • What is the Most Expensive ETF?

    Currently, the most expensive ETF is the VanEck BDC ETF which has an expense ratio of 10.07%. 

  • What is the Safest ETF to Buy?

    Generally, ETFs are considered a safe investment as long as they are a fund held by a large company and have a low expense ratio. But if you are looking for the safest ones on the market, then you should go with those that tend to survive a bear market crash, such as those dealing with the S&P 500 or government bonds. 

  • Can an ETF Fail?

    It is possible for an ETF to fail or be delisted—meaning it can no longer be bought or sold. When this happens, the ETF is liquidated and distributed to the holders of the shares. 

  • Why Choose a Mutual Fund Over an ETF?

    One reason that you may choose to buy a mutual fund over an ETF is because you have found a specific mutual fund that matches your exact desired investment strategy that you can’t find in an ETF, such as a high dividend return mutual fund. 

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