Mutual Funds vs ETFs

SUMMARY:

Mutual Funds vs ETFs

There are many differences between mutual funds and ETFs. Mutual funds are priced at the end of the day, whereas with ETFs, you can buy and sell these throughout the day whenever the market is open. ETFs and mutual funds also have different costs and fees. You can expect to see a management fee or expense ratio for both. Typically, ETF fees are less because of the passive component in ETFs.

With an ETF, there are implicit and explicit costs, which refer to the liquidity and the bid-ask spread. So, both have some sort of net expense ratio or management fee attached to them. Even though mutual funds typically have higher management fees, you might buy an ETF thinking it is relatively inexpensive, but end up paying a big premium. This is something that can be hard for people to figure out on their own. So, our advice is to stick to the main ETFs or hire an investment manager.

When we talk about ETFs, we usually talk about passive management which means that they’re just tracking a benchmark and trying to perform in line with it. That benchmark could be the S&P 500, a sector, or it could be the Broad Bond Market Index. Most mutual funds are actively managed, which means they try to outperform a certain benchmark. Again, that benchmark could be the US market as a whole, the S&P 500, or others. Lately, there have been more actively traded ETFs coming out on the market.

ETNs and Highly Leveraged ETFs

Some of the commodity funds are actually ETNs (Exchange Traded Notes), meaning they don’t actually own anything. They are just a promissory note by a bank to pay you on the performance of something. We don’t use ETNs for that reason, because if an ETN shuts down, people lose all the money they put into it. A lot of times people don’t really think about the risk involved with certain investments until they are in that situation for themselves. If you are investing in the stock market on your own, you need to be extra cautious with risk, especially with ETNs, highly leveraged ETFs, or any other investment in which you don’t completely understand the risks.

Highly leveraged ETFs are attractive because of the great returns they promise. However, as with any investment with the promise of high returns, the risk associated with them is just as high. Leveraged ETFs, for example, reset daily. There’s no annual return for them and potentially a series of bad days can erase a really good day.

Don’t Be Stuck in the Mutual Fund Mentality

Even though ETFs have been around for over 20 years, many people are still stuck in the mutual fund mentality. Mutual funds were the investment class your parents likely invested in. However, the times have changed and as a firm we try to help people understand that ETFs are a more modern and efficient way of investing in the stock market.

Download our eBook: “Buyer Beware: Why do they keep trying to sell you that annuity?”