Mutual Funds vs. ETFs: A Beginner's Guide to Investment

Posted by: TheGuarantors on November 10, 2021

Investing is a great first step towards financial growth. However, choosing the right type of investment can be confusing for a beginner. Instead of rushing in and buying a plethora of stocks or securities, you should start slow with mutual funds and exchange-traded funds (ETF). But what is the difference between mutual funds and ETFs?

For starters, both financial vehicles offer tremendous benefits and instant diversification at a super low cost. Not to mention certain tax benefits. Most importantly, you will learn a lot more about becoming an investor by choosing one of these options as your starting point. Which one is better, ETF or mutual funds? 

Continue reading our guide on mutual funds and ETFs to find out which option might be better for you.

What are Mutual Funds?

Beginner's Guide to Mutual Funds

Mutual funds use the collective money of multiple investors to buy shares and create a cumulative portfolio. This portfolio is actively managed by a  professional portfolio manager. Unlike other financial vehicles (ETFs), mutual funds have a minimum initial purchase criterion. For example, mutual funds can only be purchased after the market is closed. This is when their net asset value is set, which is typically at the end of the day.

Why is it advantageous to invest in a mutual fund? Well, mutual funds give individual investors access to various professionally managed portfolios of equities, bonds, and securities. Each shareholder has an equal stake in the gains or losses of the fund.

What you need to know is that mutual funds tend to charge annual fees commonly referred to as 'expense ratios' plus commissions (in certain cases like brokerage or sales), which can affect your returns. So, if you're thinking about investing with a mutual fund, be sure to look up and contact the necessary people. This helps you find out what your final returns will be after the expense ratio, commissions, and taxes have been deducted.

Additionally, mutual funds can be subdivided into several different types. They range from stock mutual funds to debt and even gold, with varying risk and returns. So, you have a lot of options to choose from depending on your financial goals.

What are ETFs?

Beginner's guide to Exchange-Traded Funds

An ETF, or Exchange-Traded Fund, is one that tracks an index, commodity, security, or any other type of asset. It can be purchased or sold on a stock exchange like a regular stock. This type of investment fund is similar, in some ways, to a mutual fund. For example, it lets you own a share in a large portfolio.

So, why choose an ETF over a mutual fund? Unlike mutual funds, which are actively managed, ETFs are passive in nature. In contrast to an actively managed fund where a manager picks the securities, the holdings track the present index of securities instead. Therefore, they are cheaper to buy into. Also, you do not have to pay sales to commission to a portfolio manager.

Mutual Funds vs ETFs: Which one should you choose?

Choosing between mutual funds and ETFs

When it comes to mutual funds and ETFs, ETFs are the cool, new kid in school. This type of investment has grown exponentially over the last decade. This is due to its amazingly low fees, ease of trading, passive structure, and tax benefits.

Mutual funds, on the other hand, are higher in terms of total assets in the market. Especially due to their position in retirement plans like 401K and debt funds, etc.

What you really need to understand is that ETFs or mutual funds allow you to invest in diverse portfolios by buying single security. You can actually invest in the S&P 500 by either buying into a mutual fund or an ETF.

However, you should always consider the management style and returns. How a fund is managed will impact your costs and potential returns. Actively managed funds are always going to cost more than passively managed ones. Plus, there are loads more benefits to investing in a passively managed fund.

For example, while a portfolio manager tries to beat the market with an active fund to make money, a passive fund tries to mimic the market itself. So, if the market is up, the value of your shares goes up. However, there is a risk with both mutual funds and ETFs as an actively managed fund and passively managed stock as the risk is tied to what the fund itself owns.

So, generally speaking, you need to choose a fund (ETF or Mutual fund) based on your budget and your financial goals. In order to do this, you will first need to understand the characteristics of and the expenses associated with both mutual funds and ETFs.

Final Thoughts

So, why choose an ETF over a mutual fund? Well, an ETF uses passive investing, which is cheaper and has more tax benefits. So, when it comes to Mutual funds vs ETFs, you will pay less in commission with ETFs and find that these stocks are easier to trade in compared to other types of assets.

Of course, this doesn’t mean that mutual funds are not also good investments. When it comes to extremely specific conditions like investing in stock index funds, mutual funds can actually be considerably cheaper than ETFs.

However, whether you are investing in ETF or mutual funds, you'll need to do your research on each syndicate's (mutual funds and ETFs) specific tax implications, returns, and more, before you make them a part of your long-term financial strategy.