Mutual funds vs. exchange traded funds… what’s the difference and who cares? Well, if you want to be your family’s CFO (chief financial officer) you should, so keep reading!
What’s the Difference: Mutual Fund vs. Exchange Traded Fund
If you have big financial goals, like saving for retirement or paying for the kiddo’s college education, there’s a good chance you’ll need to go beyond using a simple printable budget worksheet. Don’t get me wrong, there are many reasons to embrace budgeting and having a solid budget in place (one that you actually stick to!) is always a great place to start, but sooner or later, you’re probably going to have to make investments.
Are you still with me? I know that investing money can seem super intimidating, but that’s just because you’re facing the unknown. A quick education will help you get a basic understanding of investing. Answering the question “what’s the difference between mutual funds vs. exchange traded funds?” is a great jumping off point for the newbie investor.
I provide a mutual fund and exchange traded funds definition as well as a crash course in the video below.
Now, since humans tend to learn better when they receive information in multiple ways, allow me to reiterate the content in the mutual fund vs. exchange traded fund video.
Exchange Traded Funds: Definition
An exchange traded fund (a.k.a. ETF) is an investment security that tracks an index, a commodity, bonds, or a basket of assets. They trade like common stock on a stock exchange, which means you can buy ETFs all day. Since ETFs trade like stocks they don’t have a net asset value (NAV) that is calculated at the end of each day. Instead ETFs experience price changes throughout the day as they are bought and sold.
Mutual Fund vs. Exchange Traded Fund
Okay, so now you know what an ETF is, but how does that compare to a mutual fund? I’m so glad you asked! 😉
Remember how ETFs can be bought all day long? Well, mutual funds can only be bought at the end of the day and their value is calculated at the end of each day.
ETFs typically have higher daily liquidity and lower fees than mutual funds.
Are ETFs Expensive?
Let’s focus on fees for a second. After all, I’m supposed to be helping you save money, right? 🙂 ETFs are not expensive to buy. In fact, they are considered one of the cheapest investments to buy. Most have expense ratios of less than 1%, and many have expense ratios of less than half of a percent.
Why are ETFs Cheaper?
Back to mutual funds vs. exchange traded funds. ETFs are cheaper than mutual funds because they are passively managed. That means they don’t have an active management team making the investment decisions whereas most mutual funds do have a team.
Therefore, when you invest in an exchange traded fund you will never beat the market. If beating the market is your goal, you need to be investing in a more active management security like a mutual fund. However, that management comes with a price tag.
Tip: It’s important to remember many management teams still don’t beat the market, so do your due diligence when selecting a mutual fund.
How to Make Money with ETFs
ETFs track an index, a commodity, bonds, or a basket of assets, so if that index goes up by 1% then the ETF goes up by 1%. It is a mirror of the index. The inverse is also true of course. If the index goes down the ETF goes down.
Of course, it isn’t quite that simple thanks to something called the “tracking error.” Since an ETF only mirrors the index it only owns a representation of the index not necessarily the entire index so there can be slight deviations (tracking errors).
Don’t get too terribly hung up on tracking errors. Overall, ETFs are awesome investment vehicles to use to earn market returns.
Mutual Fund vs. Exchange Traded Fund: When to Pick ETF
There are several instances where you may want to invest in ETFs. For example, say the companies you want to invest in are large, developed companies like in a large cap fund. In those cases, it rarely makes sense to buy a mutual fund since the managers don’t typically outperform the index since there is a lot of information available about the companies already. It would likely be a smarter decision to go with an ETF like the Spider ETF with a ticker of SPY which tracks the S&P 500 Index.
Another situation where you may want to invest in ETFs is when you want exposure to a participate sector. Say you want to invest in energy but aren’t sure how to go about that. You can select an energy ETF like XLE to give you some exposure.
I also like ETFs for foreign stock market exposure. For instance, ticker EEM is the iShares Emerging Markets ETF.
How to Buy ETFs
If you’ve done the calculation of mutual fund vs. exchange traded fund and are ready to purchase an ETF, you can buy them through a broker or you can go the DIY route. If, like me, you prefer the DIY method you can use companies like TD Ameritrade and ETrade.
Before you think there’s no way you could trade your own securities, I encourage you to look into online trading platforms. You might be surprised at how easy they are to use. 🙂
Have more questions about mutual funds vs. exchange traded funds? Ask your question (or questions) in the comments!
If you’re looking for more ways to lead your family into a financially secure and frugally fabulous future, be sure to check out my eBook Secrets of a Successful Family CFO. You can also get inspired with money saving tips by following the Frugal Living Ideas & Money Saving Tips Pinterest board.