Mutual Funds or Exchange-Traded Funds, Which Are Best for You?
By Kyle Krasker
Kyle Krasker, a Shanghai-based portfolio manager at Olivar & Greb Capital Management, has extensive experience in professional investment and wealth management consulting for individuals and families. When time permits, he shares his insight in this column for That’s to highlight key sectors, market movements, or trade ideas to consider for your portfolio.
Building an investment portfolio involves researching and piecing together different investment vehicles to reach your financial goals. There are various investment vehicles that can be used to create a successful portfolio, including:
Stocks
Bonds
Mutual funds
Exchange-Traded Funds (ETF)
REITs
Closed End Funds
This article will focus on the differences between two of the most common, mutual funds and exchange-traded funds.
The Similarities
Both mutual funds and ETFs pool together investors’ money to invest in a broad range of securities, typically stocks or bonds. The funds have an objective and investment scope (for example, to invest in emerging market stocks), and will cater their portfolios to meet this objective. In today’s world, investors can find an ETF or mutual fund for nearly every investment objective – making it a worthwhile option for those new to investing.
The main benefit these investment funds give investors is the opportunity to own a large amount of stocks or bonds, without having to invest individually in all of the securities. Typical mutual funds or ETFs will have anywhere from 30-100 individual securities, with some having far more. The SPDR S&P 500 ETF (NYSE: SPY), which tracks the S&P 500 stock index, has roughly 500 securities. Buying all 500 stocks individually is not the most plausible strategy, however, investing in the ETF gives the same exposure in a much simpler way.
The Differences
The main differences between these two types of funds are their objectives and how they trade. Mutual funds typically try to beat a benchmark index (for example, the S&P 500). Therefore, they are considered actively managed, which will warrant a higher fee. An ETF is passively managed, meaning it does not try to beat a benchmark; instead, it matches the benchmark. Therefore, ETFs have lower fees because they require less management.
A key difference is that you cannot purchase mutual funds on a stock exchange like you would an ETF. ETFs trade like stocks on the open market, so you can buy and sell them during normal trading hours. On the other hand, mutual funds are traded with a fund house. Trades are placed at the brokerage, and at the end of the day, the trade will settle. This means that mutual funds are slightly less liquid because they cannot be bought or sold intraday.
A chart of the differences is shown below:
Generally speaking, we recommend using the lowest cost option, which would be ETFs. In addition, since mutual funds are actively traded, they generate higher capital gains taxes within the fund, which often get passed to the investor.
While there are many high-quality mutual funds, it is critical to only target those with a proven track record and a reasonable fee structure. Avoid mutual funds with up-front fees (front loaded) and annual charges greater than 1.5%.
At the end of the day, both mutual funds and ETFs provide the most critical role in portfolios, diversification. Diversification is what reduces risk, allows for compounding gains and ultimately lets us sleep well at night.
A final consideration is that for Americans living abroad, there can be strict reporting requirements if they own a foreign-domiciled mutual fund. This can be both a hassle for reporting to the IRS, as well as very expensive. The rule is in regards to Passive Foreign Investment Companies (PFIC), which we will cover in future columns.
Feel free to reach out to kyle.krasker@olivar-greb.com to inquire about ETFs, mutual funds, and how to decide which funds to include in your portfolio.
[Cover image via Pixabay]
Disclosures
The content in the article is O&G’s own opinion. O&G clients and our team may hold positions in the securities mentioned in this article. SEC registration does not constitute an endorsement of the firm by the Commission nor does it indicate that the adviser has attained a particular level of skill or ability. The opinions expressed in this report do not constitute a buy or sell recommendation. Please note that performance comparisons are based on historical data, are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results. Past performance is no guaranty of future returns.
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