Mutual Funds or Exchange-Traded Funds?
Updated: Sep 16, 2021
It has come to my attention during recent discussions, that some people do not realize the basic differences and/or benefits between a mutual fund and an ETF (exchange-traded fund). Firstly, both mutual funds and ETFs are a pool of many diversified assets (shares, bonds, cash equivalents, etc) designed to deliver some long term result, but how they trade, how they are managed, and what they cost are where the differences lies. Either a mutual fund or an ETF may claim to track a market index, might claim growth beyond market norms, might claim to pay high dividends, may track an industrial sector, may track a commodity sector, etc. etc., and they all deliver varying levels of risk.. They both share some similarities in their basic structure and offerings, but are also quite different in a few key areas.
One of the key differences with mutual funds are that they are “actively managed”. This means there are Fund Managers behind the scenes who are actively buying and selling assets, and/or rebalancing the assets within the fund to meet some promise of returns. But the main point is that they are (very) actively managed. Another key difference with mutual funds is they are typically only traded once a day, usually after market close. Also, you can only buy and sell mutual funds through the financial institutions that sell and manage them, using that institution as the broker. They are not traded freely on the market exchanges and, as a result, investors cannnot react quickly or easily to any market changes. The assumed expertise and amount of active management involved determines the fees, and with actively managed funds the fees are inherently much higher. An index mutual fund intended to track the market indices, and generally requiring less active management, has a fee average usually in the 1% plus range. While specialty mutual funds like a growth fund may get upwards of 1.5-2%.
ETFs (exchange-traded funds), on the other hand, are traded on the open stock market. They can be bought and sold all day long during normal market hours just like any stock. This allows investors to react quicker with their decisions and investments, should they choose. However, unlike mutual funds, if you plan to buy ETFs you will require investment accounts set up in a brokerage platform with your bank, and independent, or somewhere else like Questrade. Like mutual funds, ETFs are also a pool of many shares designed to deliver an objective, but are considered to be “passively managed”. This means they are structured to deliver returns based on an recognized index like the TSX, S&P 500, DOW, bond indices, real estate indices, etc, and are very rarely touched by the Fund Managers overseeing them. They may only be adjusted by the Fund Manager if one of the stocks is severely underperforming and falls out of grace with the portfolio’s set criteria. Some ETFs have a little more or or a little less passive management depending on what they aim to deliver, but because they have a mantra of passive management, they always have much, much lower fees than actively managed funds. The intent of an ETF is to deliver an average of the market or sector performance, and not try to beat the market or sector. An index tracking ETF can be found for 0.08% to 0.15% fees, while some of the slightly more managed ETFs e.g. the all-in-ones can be found at 0.2-0.4% fees. These are general ranges, and you will have to shop around to find what you want and what you are willing to pay. Personally, I use all Vanguard ETFs trading on the TSX, so I am using my own experience with Vanguard as a point of reference for various offerings and fees.
As an investor, it is wise to to take a more active approach to understanding your investments, without taking on actively managed investments. The first steps towards this is to first understand what you own (mutual funds or ETFs), the fund objectives, the cost of fees, and the fund returns. When looking at your returns you will want to differentiate between dividend yields and the share price, and look at how they work together over time using a dividend reinvestment plan to create total returns. Then you can decide if the cost of the fees is worth the returns or risk you are assuming.