Mutual and exchange-traded funds (ETFs) are sometimes used interchangeably since they have many characteristics and may achieve the same essential investing objective: portfolio diversification.
Both let investors acquire a basket of assets, often a combination of stocks and bonds, chosen by a team of skilled investors. However, there are substantial distinctions between ETFs and mutual funds.
Firstly, during normal trading hours for U.S.-based stock exchanges, you can acquire any ETF at its current market price, just as you would with stocks. To purchase or sell mutual funds, however, you must wait until markets close, as that is when their net asset value, a statistic representing the total worth of all the fund’s assets, is computed.
Here are some further major distinctions.
ETFs normally are formed based on what’s included in a large index like the S&P 500 or a subindex like S&P 500 consumer staples. Because ETFs monitor indexes, their composition often changes only when indexes do, which is infrequent.
According to a 2021 study released by the Investing Company Institute (ICI), a trade organization for the investment sector, yearly fees for index-tracking ETFs amount to 0.18 percent of the total value of the investment. Thus, a $1,000 investment would incur $18 in fees.
This is much less than the average equity mutual fund expense ratio of 0.50%. In this scenario, a $1,000 investment would incur $50 in fees.
In all instances, you are compelled to pay the fees regardless of the fund’s performance or ETF.
So what justifies the increased costs for mutual funds?
Level of client service
Mutual funds often have greater fees than ETFs since they are more frequently actively managed. This indicates that a team of investment professionals closely monitors the performance of the fund and trades shares based on what they feel will provide the highest return for investors.
In addition to yearly fees, many actively managed mutual funds have a minimum investment requirement. For instance, Vanguard has a $3,000 minimum requirement.
There are several exceptions due to the diversity of mutual funds. A form of mutual fund that monitors a major stock index, index funds do not have active fund managers making investment choices. Consequently, index fund expenses are considerably lower than ETF fees, 0.06% on average, according to the ICI.
Which yields superior returns?
Examine the five-year performance of the oldest and one of the most popular ETFs, SPDR S&P 500 ETF Trust (ticker: SPY), which is listed on the New York Stock Exchange. Its returns were substantially equal to those of the S&P 500.
It doesn’t have the same return as the S&P 500 because of somewhat different sector allocations. For instance, 26.93% of the SPY comprises information technology assets compared to 26.92% for the S&P 500. The expenditure ratio for SPY is 0.0945%.
Check out American Funds Washington Mutual Investors Fund Class 529-A, trading under AWSHX, one of the most popular actively managed mutual funds. Despite its expense ratio of 0.56%, it has lagged behind the S&P 500 and the SPY ETF over the previous five years. But during the past year, it outperformed the two.
This fund’s asset allocation differs significantly from SPY. The SPY returns against AWSHX do not reflect the performance of all ETFs and mutual funds because their asset allocations vary.
Choosing the right one for you
The decision mostly hinges on cost and management.
Investment minimums for mutual funds are higher and have higher expense ratios than ETFs. Due to their structure, mutual funds tend to produce higher taxes throughout their ownership than ETFs.
With mutual funds, you give up some control over when and at what price you can purchase and sell shares. However, having a team of specialists make some of these judgments is advantageous.