Deciding between an ETF or mutual fund investment? There are some important distinctions between the two that you don’t want to ignore.
ETF or mutual fund? This question comes up a lot. It’s understandable, too. On the surface, they look very similar. Some may even include the same investments. So what’s so different about them?
One way to think about this is to look at the automotive industry. Volkswagen AG (VWAGY) owns and manufactures 12 different auto brands, including Audi, Porsche, BUGATTI, and Lamborghini. The company uses the same platform and even many of the same parts on vehicles across these brands. I don’t know if you’ve been car shopping lately, but a VW Jetta is a little less expensive than a Lamborghini Huracan. (Okay, a LOT less expensive.)
If you were to just look at the chassis or the parts list, these two cars might look very similar. Obviously, once you start adding in the details, the differences become apparent. Same chassis, same parts, different vehicles. Just like ETFs and mutual funds may have similar structures and similar investments, but can be very different in your portfolio.
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ETF or Mutual Fund? What’s the difference, anyhow?
In truth, there are probably more similarities between these two investment products than there are between a VW and a Lamborghini. Here’s what they have in common:
- ETFs and mutual funds both consist of a collection of stocks and bonds.
- They help diversify your portfolio.
- They lower the risk in your portfolio.
- They are professionally managed.
- They allow you to invest in a broad selection of the market, a segment of the market such as small-cap stocks, a theme such as sustainability, or even a specific industry such as gold or air transportation.
And here are some of the differences.
- Mutual funds usually have a minimum investment requirement. ETFs do not.
- Most mutual funds are actively managed, while most ETFs are passively managed. With active management, a fund manager is shifting assets to try and beat the market. With passive management, the fund manager simply adjusts holdings as needed to match a specific index.
- Fees for mutual funds are generally higher due to the active management. However, there are ETFs with high expense ratios and mutual funds with very low expense ratios.
- ETFs trade on the open market just like stocks. You could buy five shares or 100 shares or 1,000 shares of your favorite ETF anytime the market is open.
- Mutual funds are hands-off, whereas you have to manage ETFs on your own.
How to determine which investment is better
Taking all that into consideration, which is better: an ETF or mutual fund investment? Ask anyone here at Cabot, and you’ll get some strong opinions. But first, it’s important to point out that “better” is a subjective word. If you prefer hands-on investing, ETFs are probably more in line with your personality. If you want to hand your money off to someone and let them deal with the details, a mutual fund is a better option for you.
In fact, if you have a 401k through work, you probably already have some ETF and mutual fund investments mixed in there. There’s nothing inherently better about either; it just depends on whether or not you want to pay someone (through the fund’s expense ratio) to manage your money or not. And if so, do you want them to do everything for you (mutual fund) or just split the work (ETF - where a manager does adjust the fund, but how much you’re invested is entirely up to you).
But there’s a caveat, and it goes back to those strong opinions. We aren’t big fans of mutual funds, and we prefer individual stocks over ETFs, although there are some excellent ETFs out there. Why?
You don’t have to swing for the fences to knock in a heck of a lot more runs than any actively managed portfolio. With one foot tied to an index and one eye constantly watching what peer funds are up to, active mutual fund managers are not out to make you real money. In fact, they can lose money and be quite proud of themselves if they have reached their twin goals: 1) Beat the index, 2) Beat their rivals.
As we always say at Cabot Wealth, nobody cares more about your money than you. So why let someone else make your investment decisions for you?
That doesn’t mean you’re on your own, though. Browse our website for valuable investing tips and lessons, sign up for our daily emails, download some of our free reports, or explore our premium advisories, where we give you detailed advice on investing to meet your goals.
Do you have a preference between ETFs and mutual funds?