ETFs vs Mutual Funds: Where to Invest?

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by Adedamola Bada · 8 min read
ETFs vs Mutual Funds: Where to Invest?
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Mutual funds and ETFs have very much in common, but peculiarities each of the investment choices actually make them very much different as well. Read this guide and invest your money wisely.

Both Mutual Funds and ETFs (Exchange Traded Funds) are investment options available for everyone looking to venture into the financial market. The two options have a lot in common stemming from the variety of assets and similar methods by which investors can diversify their investments. However similar, mutual funds and ETFs have major differences and variations, especially when it comes to their mode of management.

Mutual Funds

Mutual funds can simply be described as a financial vehicle consisting of large amounts of money obtained from several investors in order to invest in securities. These funds are managed by professionals who distribute the fund’s assets in a bid to obtain gains or capital profit for the investors.

Mutual funds provide investors the opportunity to access the portfolios of professionally-managed securities so that each shareholder, in essence, contributes a quota to the profits or losses of the fund. The performance of invested securities is tracked through changes in the total market cap of the fund. It is usually obtained as the aggregated performance of the fundamental investments.

In simpler terms, mutual funds involve pooling money from the investors and using the money to purchase securities such as bonds and stocks. The value of the mutual fund company at any point in time is with respect to the performance of the security asset purchased. Summarily, when a share or unit of a mutual fund is purchased, the investor is simply buying a share of the portfolio’s value.

Although stocks wield their investors with voting rights, mutual funds do not. A share of an investment in mutual funds does not exactly amount to a single holding but different securities. The average mutual fund holds several different securities giving the shareholders crucial variations in their investments at a relatively low price. This explains why the price of a mutual fund is also called the net asset value per share, expressed as either (NAV or NAVPS).

A good illustration of this would be an investor who buys only a Facebook stock right before a bad quarter. Such a person has a lot to lose compared to someone whose stock(s) on Facebook is only a portion of the person’s investment.

Types of Mutual Funds

There are several types of mutual funds, depending on the kind of securities focused on in their respective portfolios and the kinds of returns on investments (ROI) the companies expect. There is usually a type of fund for every investor. Popular types of mutual funds are alternative funds, sector funds, money market funds, target-date funds, funds-of-funds, etc.

Balanced Funds

This type of mutual fund is also called asset allocation fund because it invests in both bonds and stocks in order to reduce the risk associated with each asset class. One striking characteristic of this investment type is the fact that the fund allocation among the classes remains constant but the difference among funds will be quite glaring. The aim of this investment style is to obtain ROI but with minimal risk.

Index Funds

Index funds have become increasingly popular in the past couple of years and have a strategy that is based on the belief that it is quite expensive and often impossible to beat the market consistently. This investment type deals with the major market indexes such as the Dow Jones Industrial Average or the S&P500. This strategy is unconventional and does not require advice or research from analysts, and this way it lesses the expenses shareholders incur before they share the profit.

Fixed-Income Funds

This group of mutual funds dwells on investments that return a fixed amount on investments. Such investments are corporate bonds, government bonds, etc. Here, it is certain that the portfolio generates income which is then passed on to the investors. These funds are usually actively managed with the aim of buying low and selling higher in order to make a profit off the sale.

Equity Funds

This is the largest category of mutual funds and deals with investment in stocks majorly. Equity funds have their own subcategories – small, mid or large capital investments. Others are income-oriented, aggressive growth, value, etc. They are also classified by their investment in foreign equities or domestic stocks and based on the growth expectation of their invested stocks.

ETFs

ETFs and mutual funds are alike but unlike the latter, ETFs are traded like regular stocks and are listed on exchanges. A popular example is the SPDR S&P 500 ETF. Bonds, commodities, and stocks or a combination of securities are an example of instruments ETFs are permitted to contain. Exchange-traded funds have prices attached to them – meaning they can be bought or sold, making them marketable securities.

While mutual funds are bought at the end of a trading day, ETFs can be purchased at any time of the day, but at varying prices as the stocks pertaining to ETFs are traded all day. ETF allows variation of investments due to the numerous basal assets attached to it.

ETFs also come in various types depending on price fluctuations, speculations, investor’s portfolios, etc.

  • Bond ETFs: these are state, government, local and corporate bonds.
  • Commodity ETFs: these invest in commodities such as gold or crude oil.
  • Currency ETFs: these are pertaining to major currencies such as the Dollar or Euro.
  • Industry ETFs: these monitor specific industries such as the banking, agricultural or technological sectors for potential investment.
  • Inverse ETFs: this involves earning from declining stocks by selling them at a particular value and expecting a further decline in price in order to re-purchase at a much lower price.

It is pertinent for investors to note that Exchange Traded Notes (ETNs) could be mistaken for ETFs and the investor should be sure to confirm with the broker involved if a particular ETN or ETF as the case may be, fits into your investment portfolio.

Mutual Funds and ETFs: Similarities

Before you make a decision to invest in any of the investment instruments, let’s have a look at what actually makes them very similar:

  • They possess built-in diversification which makes them less risky investments than bonds and stocks since they consist of several other basal bonds or stock. As such, if a particular bond or stock is performing poorly, chances are the better performance of another helps cushion the loss from one.
  • Both afford shareholders with several choices pertaining to investment both in domestic and international bonds and stocks. The decision then lies with the investor whether to invest in a total market fund or a niche-specific fund or a mixture of both. It all boils down to the investment strategy and return goals of the investor.
  • Both mutual funds and ETFs are controlled by professionals who monitor and decide which bonds and stocks they would invest in on behalf of the shareholder or investor. Mutual funds and ETFs are index funds that need active management so the indexes do not divert from their intended target.

Where to Invest?

For those who prefer low minimum investment amounts, ETFs would be better choices over mutual funds as the former can be bought at market price for as low as $50 depending on the asset purchased. Mutual funds, however, have a couple thousand dollars’ minimum investment amount with a NAV of about $100/share.

For an investor that wants to have transactions executed automatically and on repeat, mutual funds are preferable as automatic payments and withdrawals can be set up as per the investor’s preferences while ETFs, on the other hand, do not afford such opportunity.

In order to have better control over the prices of trades being executed, ETFs afford investors with custom order types based on preferences and market order prices. Mutual funds, on the other hand, provide investors with the same price as everyone else at the time of purchase.

Mutual funds and ETFs offer various perks and should fit into any trading style chosen by any investor. Considering both of them should therefore not be a bad idea especially when starting out. However, it is important to note that the fees and expenses associated with mutual funds investment can be rather expensive therefore considering the expense ratio of both investment options is very important before committing capital into either of them.

Secondly, both offer specific advantages the other might not and this is dependent on the preference of the trader. For instance, traders who love to study historical data in order to monitor an asset movement would be inclined to trade ETFs over mutual funds even though historical data/price movements are no guarantee of futuristic prices.

Finally, since both options offer diversified investment options, ETFs are majorly used for sector funds while mutual funds are best for total industry funds. In summary, the investment option should be chosen based on the preference.

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