The Age Old Question: ETFs vs. Mutual Funds

One of the most common questions and discussion points we encounter is: “What are the key differences between exchange traded funds (ETFs) and mutual funds?”

Both are investment vehicles designed to give the investor exposure to a basket of securities, but there are important distinctions between the two structures in terms of transparency, trading and tax efficiency. Our CEO, Jonathan Steinberg, likes to use the analogy that mutual funds are like black-and-white TVs and ETFs are like HDTVs in full color.

ETFs vs. Mutual Funds

The first key difference between ETFs and mutual funds is transparency. The holdings of ETFs are published daily, so as an investor, you know exactly what you are holding. Mutual fund holdings are published quarterly and usually on a lagging basis. By the time the holdings are published, what the mutual fund actually holds could be quite different. Furthermore, ETFs are much more transparent in terms of trading costs.

The ETF buyer or seller bears the trading cost without impacting other investors of the fund. Additionally, the trading costs are imbedded in the ETF spread, which the buyer or seller pays, plus commissions. For mutual funds, the costs of inflows and outflows are borne by all holders of the mutual fund.

Any trading activity that occurs in the portfolio, such as trading to accommodate daily inflows and outflows, will impact those who hold the mutual fund. In terms of fees, many mutual funds have sales loads, 12b-1 fees and trading costs that are not transparent since they are not exchange traded. Many investors think they are getting net asset value (NAV) but in reality, it is NAV minus the unknown trading costs.

The second key difference between the two products is trading. A mutual fund investor can only receive NAV minus costs of a mutual fund at the end of each day. An ETF can be bought or sold throughout the entire trading day.

Additionally, since an ETF is exchange traded, that adds a further layer of liquidity. Shares of an ETF have the potential to be passed back and forth on exchange without a transaction occurring in the underlying securities. This can potentially lead to cheaper costs compared to trading the underlying basket.

This does not happen with a mutual fund. The portfolio manager will always have to transact in the underlying securities when buying or selling for an investor, especially in larger size.

Related: Still Calling for a Stock Market Crash?