Money Talks Q&A Series - ETFs vs. Mutual Funds

Q: We are keen on investing our money for the long term and would like to have our investments managed by a professional. We have been considering exchange-traded funds (ETFs) and mutual funds, and they seem to be similar. Is there a difference between the two and which is better?

A: There are many similarities and differences between mutual funds and ETFs. Understanding the details can help you decide on the investment that best meets your needs.

1. Most mutual funds are actively managed, whereas ETFs seek to match the performance of a specific financial index. Index mutual funds are similar to ETFs in this regard.

2. ETFs and mutual funds are priced differently. Mutual funds are priced by their net asset value (NAV). This is calculated by taking the value of all the holdings within the mutual fund minus any liabilities, before dividing the amount by the number of outstanding fund units. The NAV is refreshed each dealing day. On the other hand, an ETF is priced like a stock. The price reflects whatever investors are willing to pay for a share. Like a regular stock, the price of an ETF continuously changes throughout the day. While the NAV of an ETF is posted at the end of each trading day, it doesn't necessarily match the market price.

3. Both instruments allow an investor to own a wide variety of underlying securities without a significant investment. If you don't have the financial resources to purchase hundreds of stocks, bonds, and other financial instruments, both types of funds provide a means to achieve a diversified portfolio with minimal cash outlay.

4. They are bought and sold differently. ETFs are traded like stocks and can be purchased anytime when the market is open. On the contrary, mutual fund orders can only be processed at the end of the day after the NAV has been determined.

5. When you subscribe to a mutual fund, you will typically need to pay a front-end load (i.e., upfront sales charge) of a few percentage points on the total investment value. Whereas for ETFs, you'll only incur brokerage fees since it's traded like a stock.

6. Both mutual funds and ETFs charge investors an annual fee to cover the management, operating, and administrative costs of the fund. Actively managed mutual funds tend to have higher fees and expenses, whereas ETFs tend to be cheaper. 

ETF or mutual fund? Which is right for you?

It all boils down to your goals and the type of investor you are. If you trade actively and are sensitive to costs, an ETF might suit you more.

If you are seeking an investment that could potentially beat the market, then an actively managed mutual fund that could potentially outperform its benchmark might be a better choice.