Most mutual funds we know invest in fixed income or in publicly traded company securities. There are many ways to differentiate them. Perhaps the first distinction we can make is between actively managed funds and passively managed funds. Another important difference has to do with the fund’s structure, specifically whether we are talking about mutual funds or ETFs.
ETFs (exchange-traded funds), also known as traded funds, are investment funds that trade on a stock exchange. Although they can be actively managed – that is, overseen by a manager – most of them track a benchmark index, similar to index funds. The key difference is that ETFs are traded like stocks, so their price fluctuates throughout the day, instead of being set once a day.
Although there was a similar precedent in Canada, John Bogle considers that the first ETF was created in 1992. It was the Standard & Poor’s Depositary Receipts (SPDR) – also known as Spider – which invested in the S&P 500 “at low cost with high tax efficiency.” The SPDR remains the largest fund in the world, with over $500 billion in assets. The number of ETFs has grown significantly since then, and today it is estimated that there are more than 12,000.
Advantages of ETFs
The advantages of ETFs compared to conventional funds – including index funds – are related to their trading flexibility. Since they can be bought and sold at any time during market hours, they theoretically allow investors to react quickly to market changes. Additionally, they typically have lower management fees and allow for broader diversification, as they sometimes are the only means to access smaller markets.
Disadvantages of ETFs
However, experts like Bogle and financial journalist Jason Zweig warn that ETFs may not be suitable for the average investor. A useful strategy such as dollar-cost averaging might be contraindicated with ETFs because most intermediaries will charge a separate commission on each new investment made.
“Unlike indexed mutual funds, indexed ETFs are subject to regular commission charges when bought and sold, and these commissions are often applied to all additional purchases or dividend reinvestments,” Zweig explains in Benjamin Graham’s The Intelligent Investor. These costs can limit or even completely negate their advantages.
Moreover, there are ultra or leveraged ETFs, which come with much higher volatility and are geared towards short-term focus. These ETFs use debt or derivatives to amplify returns in the same way as short-term investing.
Mutual funds or ETFs: Which to choose?
The choice between mutual funds and ETFs depends on several factors. If you are focused on the long term – as we propose in this blog – conventional funds can be as practical an option as ETFs. If you prefer more flexibility and lower costs – although these can increase with transactions – ETFs have an advantage. The same applies if you are looking to take advantage of short-term market movements, thanks to their intraday trading capability.
There is no single answer to whether mutual funds or ETFs are better. The decision will depend on your financial goals, risk profile, and personal preferences. Both offer efficient ways to diversify your investment, and in many cases, a combination of both might be the best strategy. Assess your needs and consult with a financial advisor to make the decision that best suits your circumstances.
