ETFs vs Mutual Funds

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Imagine you are 22 years old and your parents just gifted you $10,000 to begin your investment journey. Where and how do you choose to allocate this money in the stock market? Let’s look at ETFs vs Mutual Funds.

Shep decides between ETFs and Mutual Funds

The sheer number of options can cause one’s mind to spin in a gazillion directions. According to Statista, “In the United States, there were 9,599 mutual funds in 2018, managing assets worth approximately 17.71 trillion U.S. dollars. Domestic equity funds constituted 41 percent of the fund market in the United States in 2018. The second most popular were bond funds, with 22 percent of the market share”. As per ETFs, there are more than 5000 global ones, according to research firm ETFGI.

Have no worries, ETFication is here by your side as you navigate the options before you.

What’s the difference between an ETF and a Mutual Fund?

Vanguard recently held a webinar “ETFs vs. Mutual Funds: Which are the Best for Me?” on November 7, 2019. They define an ETF as:

as an instrument that is traded on a major exchange that is a collection of stocks or bonds in a single fund.

The benefits of owning an ETF over individual securities is that it encompasses less risk, less work and lower costs.

A mutual fund is a completely separate vehicle that pools money from investors and has an objective to produce capital gains or produce income.

The key distinguishing features are that ETFs are more attractive to investors due to lower investment minimums and real time pricing every time you buy and sell.

Now that you know some of the major differences between ETFs vs Mutual Funds,

How should you allocate those $10,000?

According to the Wealth Coach, there is no cookie-cutter answer. Regardless of what decision you make, there are risks involved. If you decide on an ETF, you must look into the holdings and the weights given to the securities. For example, you may think you are diversified by buying a market ETF, however, you may have a large exposure to the FAANG stocks.

If you decide on a mutual fund, the risks involved are the high management fees they are known to charge and the possibility of the manager weighing a part of the market that underperforms.

You also need to take into consideration your tax situation, ETFs incur taxes only when they are sold, as opposed to mutual funds, as they incur taxes when the shares within the fund are traded.

According to MarketWatch, the odds are 1 in 20 of an actively managed mutual fund to beat the market. “Over the last 15 years, 92.2% of large-cap funds lagged a simple S&P 500 index fund. The percentages of mid-cap and small-cap funds lagging their benchmarks were even higher: 95.4% and 93.2%, respectively.”

An ETF can help mimic the market and get you on the right path. Also, costs associated with mutual funds can erode your long-term returns. Take a look at this chart:

This hypothetical illustration doesn’t represent any particular investment nor does it account for inflation. “What you lose to costs” represents both the amount paid in expenses as well as the “opportunity costs”—the amount you lose because the costs you paid are no longer invested. There may be other material differences between investment products that must be considered prior to investing. Numbers are rounded. Image credit: vanguard.com

Now that you are equipped with some basic knowledge, take the leap with ETFication and learn more about how ETFs can boost your portfolio. If you still feel a little lost, feel free to take a short quiz on what is best for your portfolio.