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Mutual Funds vs. Exchange Traded Funds

By: Elite Legacy Education, December 5, 2016

Mutual Funds vs. Exchange Traded Funds

What if I told you that there were other investment options very similar to mutual funds, but at a fraction of the cost? I’m sure many of us would be happy to hear this, especially since it’s common to instinctively turn to the bank to handle our mutual funds. By considering everything I’m about to tell you, you may be able to start saving on investment expenses and generate higher returns instead!

 

So what is this new investment option?

Behold exchange traded funds, otherwise referred to as ETFs. ETFs are essentially identical to mutual funds, but provide many benefits that mutual funds do not. In general, mutual funds and ETFs are both comprised of shares in many different securities that form a fund. However, the fundamental difference comes down to how these two assets are managed, which we will reveal shortly.

 

Let’s start by discussing what mutual funds are, before we compare them to ETFs.

Here are some of the common features of mutual funds:

  • Mutual funds only trade at the end of the day and are priced at their NAV price (net asset value)
  • These are typically purchased through brokers at banks and require that you pay a management fee (MER) to have someone handle your mutual fund. As to whether this individual manages it effectively is another story in itself.
  • Managers actively manage the securities that comprise the fund, so your mutual fund performance is at the hands of your broker
  • Mutual funds typically require that you stay for at least 90 days after the original buy-in creating a sort of “lock-in” effect.

These are some of the main points about mutual funds that you need to know before we further discuss ETFs.

 

How do ETFs differ from the features of mutual funds just mentioned?

Here are the features of ETFs that typically set them apart from mutual funds:

  • This type of security trades on a stock market with intraday prices. This means that the price is always fluctuating much like a company’s stock.
  • ETFs typically have cheaper management costs compared to mutual funds since you can trade them yourself and buy them online. This is a huge element of cost savings offered by ETFs compared to mutual funds. It’s also an example of how technology reduces costs compared to human labor.
  • ETFs can be traded anytime at your discretion. So long as you find another buyer on the market, the choice is yours.
  • ETFs typically match an index of sorts, whether it’s for the overall market (i.e., S&P 500) or for specific industries. That way, you can bet on the general market or certain industries that you have a good feeling about. This represents a form of passive investment compared to mutual fund managers that actively manage which securities are held in a fund.

 

As you can see, the main differences are in terms of price and active versus passive management strategies. The latter is also a contributor to a lower price associated with ETFs.

 

The choice is yours, but here’s one final point to keep in mind.

History has shown that on average, most mutual fund managers do not outperform the market and in fact, only beat it by around 1% on average. Whether this slight improvement is worth the extra MER fees you pay is up to you. On the other hand, the market has grown since the inception of the stock market. ETFs are designed to reflect this growth through its passive approach. So again, it’s up to you to decide whether you have the confidence in your mutual fund manager to earn extraordinary returns that will also compensate for the higher MER fees as compared to the costs associated with ETFs.

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