The information in this article is meant to be educational and should not be taken as personalized financial advice. Consider speaking with a qualified financial advisor to find the investment approach that’s right for you.
Investing can help you make the most of your money. But before you begin, you should learn about different investment vehicles and how they may serve your needs. Exchange-traded funds (ETFs) and mutual funds are two beginner-friendly options. This article will provide a detailed ETFs vs. mutual funds comparison.
Here’s a closer look at the difference between the two investments and how to decide which option is better for you.
What Is the Difference Between a Mutual Fund and an ETF?
Before diving into a side-by-side comparison, let’s look at the basic definition of an ETF and a mutual fund.
Exchange-Traded Funds (ETFs)
An ETF is an investment fund that trades on a stock exchange, just like a regular stock. It holds a basket of assets—such as stocks, bonds, commodities, or a mix of them—and gives investors an easy, low-cost way to diversify without having to buy each asset individually.
Sometimes, the investments are related. For instance, if you invest in a silver ETF, the fund may hold both physical silver and silver mining companies.
It’s important to have a diversified portfolio, with investments spread across many asset classes. Because each ETF holds multiple asset types, your investment is automatically diversified.
Most ETFs are passively managed. They try to replicate a specific index, such as the S&P 500, which tracks the performance of a particular market segment.
So how do ETFs make you money? As the value of the various assets in the fund increases, the value of your shares does, too. Some ETFs also generate profit from dividends on stocks and interest on bonds.
Mutual Funds
A mutual fund is a way for many investors to pool their money to invest in a mix of stocks, bonds, and other assets. Instead of choosing each investment yourself, a professional manager makes those decisions for the group.
Mutual funds have some key similarities to ETFs. Namely, because mutual funds also contain baskets of different securities, they offer automatic diversification.
Most mutual funds are actively managed, meaning a fund manager tries to outperform the market. Actively managed funds can potentially generate greater returns, but they also come with more risk and higher management fees.
Mutual funds are also traded differently from ETFs. Shares in an ETF can be easily bought and sold, much like any stock. By contrast, mutual funds can only be traded once per day after the market closes.
ETFs vs. Mutual Funds Comparison
Are ETFs good for beginners? What about mutual funds? The answer depends on what you’re looking for. Here’s how these two investments stack up in a number of different categories:
How They’re Purchased
How can a beginner start a mutual fund investment? You can buy ETFs through any brokerage account—like Fidelity, Vanguard, Schwab, or even apps like Robinhood. You just search for the ETF’s ticker symbol and place a buy order, similar to buying a stock.
Mutual funds are also bought through a brokerage, but some are only available directly from the fund company. Instead of trading during the day, you submit your order, and it goes through at the fund’s end-of-day price.
Total Cost to Invest
In terms of cost differences, ETFs vs. mutual funds can vary. Because most ETFs are passively managed, investing in them typically costs less. Actively managed mutual funds are more expensive, and even passively managed mutual funds usually come with higher fees than ETFs.
Minimum Investment Amount
ETFs usually have a low barrier to entry because you can start by buying just one share, and some brokerages even allow fractional shares. Mutual funds often require a set minimum investment—sometimes a few hundred or even a few thousand dollars, making them a bit harder for beginners to access right away.
Liquidity
When it comes to liquidity and flexibility, ETFs vs. mutual funds have some important differences.
An investment with high liquidity is easy to sell quickly. ETFs are generally more liquid because they can be traded throughout the day. Mutual funds have less liquidity because they can only be traded once per day.
Tax Consequences
The tax efficiency of ETFs vs. mutual funds is also worth considering. With an ETF, you’re less likely to have to pay capital gains taxes. Actively managed mutual funds have a major tax disadvantage: When the manager sells a security, you may owe capital gains taxes even if you don’t sell your shares.
ETFs vs. Mutual Funds: Pros and Cons
So what’s the best investment: ETFs or mutual funds? It comes down to your individual circumstances, but here are some notable benefits and drawbacks of each.
Pros and Cons of ETFs
Advantages of ETFs include:
- Usually inexpensive and accessible
- Diversifies your investment
- Highly liquid
However, certain disadvantages also exist, such as:
- With passive ETFs, your investment won’t outperform the market
- In the event of a market downturn, your shares could lose value
The type of ETF you choose can also affect your experience. For beginners, standard index ETFs are usually safer, while inverse or leveraged ETFs carry far more risk.
Pros and Cons of Mutual Funds
Before you make a decision regarding ETFs vs. mutual funds for beginners, take a look at the following advantages of mutual funds:
- Like ETFs, they’re automatically diversified ‘
- Managed funds may bring the possibility of greater returns
- Options with low minimum investments are fairly accessible
Those perks should be weighed carefully against the potential downsides, namely:
- You could owe capital gains tax when the fund manager sells a security
- Fees are usually higher than passive ETFs
Take your time when making your decision, and don’t be afraid to seek expert advice.
ETF vs. Mutual Funds: Which Is Better?
Not sure how to choose between ETFs and mutual funds? If you’re new to investing, discovering new investment vehicles can feel like an adventure. But like any explorer in unfamiliar territory, you might benefit from the help of an experienced guide.
Doing your research and making an ETFs vs. mutual funds comparison is great. However, when you have the help of a financial advisor, you can confidently make investment decisions to shape your financial future.
