A Beginner's Guide to ETFs and Mutual Funds

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Which Is Right For You? ⎯ ETFs vs. Mutual Funds

Mutual funds can sometimes grant individual investors access to a broad range of investments and professional management, even without large sums of money. So, what is a mutual fund? A mutual fund is essentially a company which pools together capital from investors and then manages the investment.

These funds are managed by professional fund managers who can make investment decisions on behalf of the investors. Catering to different interests, investment objectives, and risk appetites, there are different types of mutual funds—such as equity funds, bond funds, money market funds, and balanced funds.

ETF stands for exchange-traded fund. Like a mutual fund, an ETF is also an investment fund—but they differ in some important respects. Prices can fluctuate throughout the trading day with an ETF, meaning that rather than the prices changing between trading days the price can change intraday.

Among the reasons for this includes that they can be bought and sold at any time during market hours. ETFs are often designed to watch the performance of an index, such as the S&P 500, and might aim to try and at least match it. An example of this would be the Vanguard S&P 500 ETF (VOO) or the SPDR S&P 500 ETF Trust (SPY) vs the index fund SPX.

They can include various asset classes like stocks, bonds, commodities, or currencies and can even cover different regions of the world or sectors of the market.

When comparing mutual funds and ETFs, there are a few notable differences. For one, mutual funds are generally only bought and sold at the end of the trading day, whereas ETFs are traded on exchanges at market prices throughout the day (1).

Moreover, mutual funds are typically actively managed, meaning the fund managers actively buy and sell securities based on their investment strategy, while many ETFs are passively managed.

Consequently, ETFs can sometimes have lower expense ratios compared to actively managed mutual funds. Additionally, mutual funds are often subject to sales charges or loads, while ETFs often do not have such charges.

Both mutual funds and ETFs can provide investors with diversification, professional management, and accessibility to a broad range of investments. The choice between the two depends on an investor's preferences, investment goals, as well as trading style.

Mutual funds may suit those seeking active management and a long-term investment approach, while ETFs may appeal to investors looking for flexibility, lower costs, and liquidity.

Types of Mutual Funds

A mutual fund offers individuals an opportunity to invest in a professionally managed portfolio, even without a huge amount of investment capital. If you’re wondering what a mutual fund is in simple terms, we’ll explore some examples to offer a better idea.

There are a few different types of mutual funds to invest in, but which type to choose depends on the preferences, goals-based investing (2), strategies, and risk tolerance of different investors. To invest in different types of securities or markets, individual investors may choose certain mutual funds or types of mutual funds (3). To better understand the nature of a mutual fund, examples of some different types can be helpful:

• Equity Funds: These funds generally focus on investing in stocks. They can focus on specific sectors, such as technology or healthcare, or target companies of different market capitalizations.
• Money Market Funds: These funds are often designed to carry a high level of liquidity by investing in highly liquid short term and stable assets. Some investors might consider these investments that they might use in an aim to achieve more stability.
• Balanced Funds: These funds allocate investments across different asset classes, such as stocks, bonds, and cash. They often aim to take a balanced approach to both growth and income. Some investors might be interested in their sometimes-broad approach to types of securities.

Some potential advantages of mutual funds include professional management, diversification, and accessibility. Mutual funds are managed by experienced professionals who conduct research and make investment decisions on behalf of investors. Diversification across various assets helps manage risk. Additionally, mutual funds can be easily bought or sold, providing liquidity to investors.

Still, they are not without their share of potential disadvantages. Mutual funds can charge fees, including management fees and potentially sales charges. These expenses can affect investment returns. When comparing potential mutual funds, one thing that investors may consider is fund management fees comparisons.

What’s more, like all investments, mutual fund investments are subject to market risk, and the value of the investment can fluctuate, and investors will have less control over the individual securities that a fund decides to invest in.

While there are advantages like professional management and diversification, investors should be aware of fees and market risks associated with mutual fund investments.

Common ETF Examples

ETFs represent a way to make sometimes diverse investments through stock exchanges, just like one might with an individual stock. To better understand what ETFs are, it can be helpful to look at some of the types of ETFs that investors might be able to choose from.some examples of different types of ETFs:

• Equity ETFs: These ETFs aim to track the performance of specific stock indexes, such as the S&P 500 or the Nasdaq-100. They provide investors with broad market exposure or focus on specific sectors or regions.
• Commodity ETFs: These ETFs can track the performance of specific commodity indexes or invest in commodity futures contracts. Examples of commodities are gold, oil, or soybeans.

One advantage ETFs have over mutual funds is that ETFs can be bought and sold at market prices throughout the trading day, while mutual funds are typically bought or sold at the net asset value (NAV) at the end of the trading day. This gives ETF investors the ability to take advantage of intraday price fluctuations and implement different trading strategies.

When comparing ETFs to individual stocks, one key difference is that ETFs provide exposure to a diversified portfolio of assets, while stocks represent ownership in a single company. When it comes to ETF vs stock, there are a few things to consider. ETFs can offer diversification and reduced single-stock risk compared to investing in individual stocks.

While ETFs have advantages, it is important to consider potential disadvantages. ETFs can carry brokerage commissions and bid-ask spreads, which can impact costs.

Additionally, ETF prices may deviate slightly from the net asset value due to market demand and supply factors. The fact that ETFs can be traded throughout the day also may lead to higher levels of short-term trading and potential capital gains taxes.

ETF vs. Mutual Fund Performance

When comparing ETF vs mutual fund performance, several factors come into play that can influence their returns. ETF vs mutual funds pros and cons can depend on the needs of individual investors, and many different factors can affect which one may be a better option for any individual.

What advantages exchange-traded funds (ETFs) have over mutual funds can depend on the individual investor. Each type of investment has its own value, and different investors may be interested in different investments for a range of reasons.

As such, different considerations associated with different investment types may be considered pros or cons depending on the individual.

We can look at how some of the differences between mutual funds and ETFs might affect what they offer investors.

Importantly, ETFs can be traded during the trading day, rather than only at the end of the trading day, which can be an important consideration for some investors who are interested in market fluctuations during the trading day. Some mutual funds might also be more actively managed than some ETFs.

Mutual funds, which are more actively managed, may aim to secure robust returns, but also may end up being more volatile in value over time. As with any investment, this can vary greatly between individual investments.

Average Investment Management Fees

The fund management fee is typically expressed as an annual percentage of the fund's assets under management (5). It covers various expenses such as administrative costs, portfolio analysis, and marketing. ETFs may potentially have lower management fees in some instances. ETFs can take a less active management approach compared to some mutual funds, which can in some cases translate to lower management fees for investors.

In addition to management fees, investors should also consider other types of investment fees, such as transaction fees, redemption fees, and account maintenance fees. Transaction fees are charged when buying or selling ETF or mutual fund shares, while redemption fees may apply when selling shares within a specific time frame. Account maintenance fees are charged for the administration and maintenance of the investment account.

These costs can have a significant impact on overall investment returns. Higher management fees can eat into investment gains over time, reducing the net return for investors.

Therefore, it is important to consider the expense ratio, which includes the management fee and other operating expenses, when comparing investment options. The average investment management fees vary across ETFs and mutual funds, and investors should assess the fees in relation to the potential returns and performance of the fund.

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References:

1. “​​Invest in ETFs or Mutual Funds?”, December 29, 2022, magnifi.com, magnifi.com/learn/invest-in-etfs-or-mutual-funds
2. “Choosing Investing Goals: The First Step In Reaching Your Financial Targets”, February 24, 2023, magnifi.com, magnifi.com/learn/choosing-investing-goals
3. “Mutual Funds: Different Types and How They Are Priced”, March 13, 2023, investopedia.com, investopedia.com/terms/m/mutualfund
4. “Management Fees”, March 16, 2023, corporatefinanceinstitute.com, corporatefinanceinstitute.com/resources/wealth-management/management-fees/

Disclosures:

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The information and data are as of June 15, 2023, unless otherwise noted and subject to change. This blog is sponsored by Magnifi.

This material is provided for informational purposes only and should not be construed as individualized investment advice or an offer or solicitation to buy or sell securities tailored to your needs. This information covers investment and market activity, industry, or sector trends, or other broad-based economic or market conditions and should not be construed as investment research or advice. Investors are urged to consult with their financial advisors before buying or selling any securities. Although certain information has been obtained from sources believed to be reliable, we do not guarantee its accuracy, completeness, or fairness. Past performance is no guarantee of future results. This content may not be reproduced or distributed to any person in whole or in part without the prior written consent of Magnifi. As a technology company, Magnifi provides access to tools and will be compensated for providing such access. Magnifi does not provide broker-dealer or custodial services.

Neither Asset Allocation nor Diversification guarantee a profit or protect against a loss in a declining market. They are methods used to help manage investment risk.

Exchange Traded Funds (ETF’s) are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from the Fund Company or your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.

Indices are unmanaged and investors cannot invest directly in an index. Unless otherwise noted, performance of indices does not account for any fees, commissions or other expenses that would be incurred. Returns do not include reinvested dividends.

The Standard & Poor's 500 (S&P 500) Index is a free-float weighted index that tracks the 500 most widely held stocks on the NYSE or NASDAQ and is representative of the stock market in general. It is a market value weighted index with each stock's weight in the index proportionate to its market value.

The Nasdaq 100 is an index composed of the 100 largest, most actively traded U.S companies listed on the Nasdaq stock exchange. This index includes companies from a broad range of industries with the exception of those that operate in the financial industry, such as banks and investment companies.

Investments in commodities may have greater volatility than investments in traditional securities, particularly if the instruments involve leverage. The value of commodity-linked derivative instruments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity, such as drought, floods, weather, livestock disease, embargoes, tariffs, and international economic, political, and regulatory developments. Use of leveraged commodity-linked derivatives creates an opportunity for increased return but, at the same time, creates the possibility for greater loss.

Active portfolio management, including market timing, can subject longer term investors to potentially higher fees and can have a negative effect on the long-term performance due to the transaction costs of the short-term trading. In addition, there may be potential tax consequences from these strategies. Active portfolio management and market timing may be unsuitable for some investors depending on their specific investment objectives and financial position. Active portfolio management does not guarantee a profit or protect against a loss in a declining market.