There are many benefits to investing in either ETFs or mutual funds.
The benefits are significant enough to attract trillions of investor dollars.
For example, near the end of 2020, the Investment Company Institute reported that there was $21.8 trillion invested in mutual funds and $4.7 trillion dollars invested in ETFs.
However, the growth rate of total ETF assets is about twice that of mutual funds.
So what benefits do ETFs and mutual funds share?
Similarities between ETFs and mutual funds
- Both invest in a basket of assets.
- As a result, both offer diversification.
- This inherent diversification mitigates individual stock risk.
- Both offer an extremely wide variety of investment options.
- Both are overseen by professional portfolio managers.
So both ETFs and mutual funds offer a relatively quick and easy way to diversify a portfolio.
So what’s the difference?
Differences between ETFs and mutual funds
- Mutual funds tend to have investment minimums (e.g. $3,000) whereas ETFs don’t.
- ETFs can be bought and sold at any time during the trading day whereas mutual funds trades are only executed at its daily closing price.
- Since ETFs trade just like a stock, the ability to execute special orders (e.g. limit orders, stop orders, selling short) is an option. This is not the case for mutual funds.
- ETFs tend to offer more narrowly defined sectors / niches as compared to mutual funds.
- ETFs can be more tax-efficient than mutual funds. Why? ETFs incur capital gains taxes only when you sell. Mutual funds incur capital gains taxes when the fund management team sells assets within the portfolio.
- Mutual funds tend to have higher fees and expense ratios compared to ETFs.
- Thinly traded ETFs can have relatively wide bid / ask spreads. Mutual funds always trade at net asset value and therefore don’t have any bid / ask spreads.
- Some mutual funds can have fairly significant front-end or back-end loads.
ETFs vs Mutual Funds Summary
Add it all up (e.g. flexibility, options, low cost, no minimums, tax efficiency) and it is easy to understand why ETF assets are growing so rapidly.
Addition to that, it doesn’t take much to get access to this ETF universe.
Simply open up a $0 commission online brokerage account and you have the universe of ETFs at your fingertips.