Mutual Funds vs ETFs

Mutual Funds vs ETFs: Which ones are right for you?

Whether you work with an advisor, manage your own investments, or invest with a robo-advisor, chances are good that some or all of your money is invested in mutual funds or exchange-traded funds (ETFs). But distinguishing between these two popular types of investments can be a little perplexing. This short, practical comparison is designed to help you understand their respective benefits and limitations, and choose the one best suited for your investing needs and objectives.

Similarities

They offer great diversification: Mutual funds and ETFs both pool the assets of many investors in order to achieve scale and keep costs down. Generally, both invest in a large basket of individual securities, giving investors an efficient way to achieve excellent diversification.

They give you lots of options: Both of these fund types give investors access to a huge range of options, allowing you to build a portfolio diversified by asset class (equity, fixed income, cash), geography, industry sector, capitalization size, and currency.

Both also offer you choices when it comes to management style. For example, most mutual funds are actively managed. This means they have a portfolio manager actively overseeing their investments, analyzing the market and making trading decisions based on fundamental analysis or macro-economic trends, attempting to outperform an applicable benchmark.

But there are also passively managed mutual funds available, such as index funds, which are designed to simply track the returns of an established index (like the Dow Jones Industrial Average or the S&P/TSX Composite). And while most ETFs are passively managed, there are a growing number of actively managed options too.

They’re affordable: Both mutual funds and ETFs are affordable to own—they allow all investors to have a well-diversified, professionally managed portfolio for a relatively low ongoing fee. The primary component of that fee, called the MER or Management Expense Ratio, varies based on several factors, including the size of the fund, the kind of assets held, and whether the manager passively follows a benchmark or actively trades securities in the fund. On average, the MER for ETFs is even more affordable than for mutual funds. This is partly explained by the fact that the structure of ETFs allows them to have lower operating costs. Also, some mutual funds pay an ongoing fee to the dealer, to compensate the advisor for their financial planning services. More on this below.

Differences

How they trade: ETFs trade on stock exchanges, similar to stocks, with access via a brokerage. Mutual funds do not trade on exchanges. They are bought and sold through the fund company, sometimes directly and sometimes via a dealer or brokerage.

Costs to buy and sell: Buying or selling an ETF usually entails paying a brokerage commission. But some brokerages offer their clients a break. For example, Qtrade Investor offers its clients a list of 100 ETFs that are free to buy and sell. Buying or selling mutual funds may or may not involve paying commissions, or “loads.” It depends on the type of arrangement the investor has with the dealer or brokerage.

When investing in mutual funds with an advisor, you can expect your advisor to review the fees with you. And whether you’re working with an advisor or purchasing mutual funds on your own from an online brokerage, be sure to read the fund’s prospectus. It will tell you important information such as the management fee, the fund’s strategy and objectives, its past performance track record, and more.

Often, part of a mutual fund’s MER goes to paying the dealer, to compensate the advisor for monitoring the investor’s portfolio and for continuing to provide financial planning expertise. This ongoing payment is called a trailer fee, and it allows the investor to benefit from professional advice without needing to pay the advisor directly. Otherwise, in a “fee-based” relationship, investors pay their advisor directly for their services, usually based on a percentage of the value of the assets in the portfolio. In these arrangements, which typically suit higher net worth investors, the advisor should recommend mutual funds that do not pay a trailer fee, and have a lower MER as a result.

As a rule, if you work with an advisor and you’re not paying them directly, then your portfolio likely holds mutual funds or other securities that pay a trailer fee to the dealer. But if you’re working with an advisor and paying them directly, then your portfolio likely holds ETFs or no-trailer fee mutual funds, or other securities that do not have a trailer fee.

Tips for Self-Directed Investors

“No-load” mutual funds are a good choice if you’re investing smaller amounts on a regular basis, because you don’t pay any commissions. If you were to buy ETFs in small regular amounts instead, the commissions could quickly add up. If you have larger sums to invest, on the other hand, you might be better off choosing lower-cost ETFs, which could be more cost-effective over time.

If you’re an active trader with a short-term outlook, and you wish to trade funds, you should choose ETFs. Since they trade on exchanges, they’re highly liquid, their prices fluctuate continually, and they can be bought and sold quickly. Mutual funds are best suited to buy-and-hold investors with a long-term outlook. Mutual funds can’t be traded instantaneously; their prices are determined after market close each day.

As a self-directed investor, you aren’t receiving professional advice, so any mutual funds you hold shouldn’t be paying a trailer fee to the dealer. Instead, opt for D-series funds, or equivalent funds that don’t pay a trailer fee, as they’ll have a lower MER.

Tips for Robo-Advice Investors

Robo-advice (or digital advice) portfolios typically hold ETFs, low-cost mutual funds, or a mix of both. Typically, you pay one low fee for the portfolio management services, and the robo-advice service takes care of all the investment and rebalancing decisions. Once you set up your account, there is very little to do, other than continuing to add funds to your account. The main tip is to update your profile if any of your financial objectives or life circumstances change – this ensures that your portfolio continues to match your needs for long-term growth and capital protection.

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Securities are offered through Qtrade Securities Inc., Member of the Canadian Investor Protection Fund. VirtualWealth is a trade name of Qtrade Securities Inc.

The information contained herein is provided by TCU Wealth Management for general informational purposes only and is not intended to provide, and should not be relied upon as providing, legal, accounting, tax, financial, investment or other advice, or a solicitation to buy or sell any securities.

 

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