What’s The Difference Between a Mutual Fund and an ETF?

When you look at your investment portfolio, you may find a few things: mutual funds, exchange traded fund (ETFs) and quite a few others. If you’re deeply involved in retirement planning, you probably know the difference between a mutual fund vs. an ETF.

However, many people don’t know the key differences between these two, nor do they worry about it – especially if these accounts make good returns.

We’re going to walk you through the concept of a mutual fund and an ETF, how they differ and when each is beneficial.

ETF vs. Mutual Fund: Understanding the Basics

ETFs and mutual funds are different, and they each have different structures. Before we go into the main differences, it’s crucial to define mutual fund and ETF.

What is a Mutual Fund?

A mutual fund is a way to diversify an investment portfolio. For example, there was a time when people trying to secure their retirement would invest in IBM, Google, energy stocks and so on, but they were required to purchase each stock separately.

Mutual funds have a purpose, such as mimicking the S&P 500, specific sectors and so on.

The purpose is what makes up the entire fund. As an investor, if you want to mimic the S&P 500 and invest in a mutual fund to do this, you can be confident that the fund will include a mix of all stocks in the index. Additionally, you don’t have to manage each stock individually.

One mutual fund can include 50 to 1,000 individual stocks to make investing more efficient because the diversification is already done for you.

Think of a mutual fund as a company that has a stockbroker who works behind the scenes to manage diversification.

When you own mutual funds, the one thing to know is that when you sell a share in a mutual fund, it’s not done until the end of the day. So, you may put in a sell order at 9 am, but the sale doesn’t happen until 4 pm when the markets close.

If the market goes or up or down during this time, you’ll be impacted as a result.

What is an ETF?

An ETF is similar in nature to a mutual fund, and while they’re vastly popular, they only came about in 1992. Due to their efficiency, ETFs are an excellent option. When selling an ETF, the structure allows you to sell in the same way as an individual stock.

You can sell an ETF at any time of the day.

So, if you’re invested in a technology ETF, you benefit from the entire industry without the risk exposure of investing in just one stock. The price movement of the ETF is live, so you can sell at any time to recognize the real-time price.

Buying and Selling Mutual Funds vs. ETFs

We looked at the buying and selling of mutual funds and ETFs, but let’s look at a clear example of the two because it can be quite confusing. Let’s run through a scenario of buying and selling a mutual fund first:

  • It’s 10 am in the morning and the mutual fund is $100
  • You put in a buy or sell for the mutual fund
  • The buy or sale doesn’t go through until the market closes at 4 pm
  • At 4 pm, the mutual fund is valued at $80 a share

If you were buying in the above scenario, you would benefit from the lower share price at the close of the market. Sellers would see share value fall by 20%, losing out on significant profits.

ETFs offer the benefit of immediate sales. Here’s an example:

  • It’s 12:30 pm and shares are up 25% on the day.
  • You put in a sell order.
  • The sale is immediate, and you sell at the high of the day.

Since ETFs are sold just like a stock, you can react to current market conditions, which is beneficial. You can also purchase ETFs in the same way.

Over time, there has been the evolution of ETFs turning into actively managed funds.

What is Active Management?

If we go back to our section on mutual funds, you’ll remember that mutual funds have a manager that works to keep a portfolio diverse. For example, let’s assume that the company’s technology mutual fund includes Apple because it’s one of the leading tech companies in the world.

If Apple stock started falling drastically on poor financials and key leadership leaving the company, active managers would sell the shares in Apple and adjust to market conditions.

Through active management, stocks enter and exit the fund to pad investors against losses and keep the fund profitable.

Actively managed ETFs work in this same way, yet you can sell the ETF immediately, too. The trading and efficiency of the ETF allow you to sell off the share while benefitting from active management.

Fees and Costs

Mutual funds are set up as a company, so you’ll find that they have fees and costs that are often more expensive than an ETF counterpart. You’re paying for the company’s financial experts to manage the fund in the best way possible to maximize returns.

However, fees and costs are often higher for the mutual fund because the company has a lot of overhead.

ETFs are more efficient, so the cost of maintenance is typically a little lower than a mutual fund. Brokerage fees are often not an issue if you invest in ETFs, but they can become expensive if you regularly invest small amounts of capital. Making larger investments less frequently may be the better option in this case.

However, the total fees for an ETF are often significantly less than a mutual fund.

Wrapping Up

We’re not saying that ETFs or mutual funds are better, but we use ETFs almost exclusively because they cost less and give you more control over your investments. We’re not saying that there aren’t great mutual funds out there, but they’re just not our preferred option.

ETFs offer the flexibility to sell or buy at any time while the market is open, and this is a freedom that mutual funds simply don’t offer.

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What is an Exchange Traded Fund (ETF)?

You may have heard of an exchange traded fund, or an ETF before when trying to plan out your retirement or boost your investment portfolio. But what is an ETF and how would you benefit from one?

That’s exactly what we’re going to discuss in this article. We’re going to cover two main concepts:

  1. What is an ETF?
  2. Action items to secure your retirement

What are Exchange Traded Funds?

ETFs have grown in popularity over the past few years, with a lot of money being funneled into them for people’s retirement. We also use them in our own practice, but they should be a part of a diverse portfolio rather than the only investment that you make.

We’re going to compare an ETF to a few investment vehicles so that you have a clear understanding of ETFs and why you may want to add them to your retirement plan.

What is an ETF?

An ETF is a stock, and you can purchase it in the same way that you buy an individual stock. But the ETF itself is not a singular company. When you purchase an ETF, you’re buying into a stock of stocks.

If you wanted to purchase technology stocks, you might consider Google, Amazon, Oracle, Microsoft and plenty of others. 

You would have to sit down, do your research and then purchase the stocks separately. An ETF can make this process easier by allowing you to purchase shares in the ETF, which contains a diverse set of technology stocks.

One purchase allows you to purchase a nice portfolio of stocks without needing to sit down and pick and choose stocks. It’s a lot easier to manage a single ETF than it is to manage 20 tech stocks.

If you know anything about mutual funds, you may assume that they’re the same as an ETF, but they’re not.

ETFs vs Mutual Funds

Mutual funds are one of the most common and original forms of investing outside of a single stock. A mutual fund is, at the heart of things, a company that has different investment objectives.

The objective can be:

  • Mirror the S&P 500
  • Mirror a sector, such as tech or healthcare

The company behind the fund will align the fund’s stocks with this objective. Within a mutual fund, there are many moving parts, including a portfolio manager and various other employees.

A mutual fund will purchase a variety of stocks and place them into their fund.

Mutual funds are a great way to invest in a more hands-off manner because you don’t have to actively manage the mutual fund. The main drawback of the mutual fund is that there are management fees, which can be high.

Since the mutual fund is a company with employees and researchers, they do have fees, which eventually eat into your investments.

ETFs are a natural move forward because they’re more cost-effective than a mutual fund.

Another major difference between an ETF and a mutual fund is that when you put in a buy or sell order for a mutual fund, the order doesn’t go through until the market closes for the day. This can be bad for your investment.

Let’s see an example.

  • Overnight, a bunch of market indicators point to energy stocks dropping tomorrow.
  • You put in a sell order at 9:30 in the morning to avoid losses.
  • Mutual fund sell orders aren’t executed until the market closes, so you sustain losses.

You’ll find a lot of retirement accounts, such as a 401(k), relying heavily on mutual funds. 

Actively Managed ETFs

A new trend is popping up where people are gravitating toward actively managed ETFs, which are very similar to mutual funds without the constraints of only being able to purchase or sell at the end of the trading day.

The downside of an actively managed ETF is that you’ll pay more fees.

If you want to manage your portfolio, you can simply sell the ETF and purchase another one if the ETF isn’t performing well. So, you have a lot of options when it comes to ETFs, and if you don’t mind paying the additional fees, you can even choose an actively managed ETF.

You can also choose the old school investment route where you purchase single stocks, add them into your account and manage everything yourself.

ETF vs Stock Purchases

If you want to build a portfolio of stocks, you can go out and purchase stocks individually. You may want to invest heavily in healthcare stocks, or perhaps you’re interested in small- and mid-sized companies.

You can go out and purchase a lot of individual stocks to properly diversify your portfolio.

But you want to manage your risks when you’re investing your retirement. If you purchase just one or two hot stocks, you can make a ton of money or lose a ton of money. Instead, purchasing a mix of stocks across sectors allows you to take on less risk in your portfolio.

Volatility is less of a concern when you have stocks in multiple sectors.

You may own hundreds of individual stocks, leading to statements that span dozens of pages. It can easily get confusing when trying to figure out which stock is a small- or medium-sized company, and then keeping up with all of these companies can be very difficult.

Researching the direction of each company and their stock is a full-time job in itself when you have a portfolio of 100 or 200 stocks.

ETFs, on the other hand, allow you to purchase 100s of stocks at once. You purchase into an ETF that has massive diversification that helps keep volatility low and reduces your own management. It’s also much easier to see an overview of your portfolio with an ETF versus hundreds of stocks.

Remember, ETFs can be bought or sold just like stock, so your buy or sell order goes through immediately. 

Real World Example of ETFs in Action

Last year, in 2020, the pandemic hit, and the market was starting to fall. We chose to sell off our ETFs as the market dipped, sat on cash, and then bought back in when stimulus checks were sent out and the market started to perform better.

If you remember, Zoom and Amazon were performing very well and benefitted from the pandemic, along with other stocks.

Online and tech companies, especially large cap ETFs, were our go-to choice because these were the stocks that were performing best. When these companies started to cool towards the end of the year, we moved back to small- and mid-cap companies that began to perform very well.

You can choose a broad asset class, such as technology, or you can narrow your ETF down further with biotech ETFs.

ETFs are a great option because they allow you to purchase:

  • Indexes
  • Bonds
  • Stocks
  • Precious metals
  • Different classes of ETFs
  • Country-based ETFs

From a fee perspective, ETFs are more affordable than other options available. We’re seeing the entire investment world start to see the value of ETFs and even some 401(k) plans are moving in this direction.

If you want to learn more about what we do or how we can help you secure your retirement, you can sign up for 15-minute introductory call with us.