ETF Vs. Mutual Fund: Which Option Is Better For You?

When it comes to building an investment portfolio in the stock market, exchange-traded funds (ETFs) and mutual funds are worthwhile options to consider. But if you aren’t sure of the merits of ETFs and mutual funds, it’s helpful to get educated before moving forward with either option.

We explore both types of investment opportunities to help you decide if an ETF or mutual fund is the right choice for your portfolio.

Differences Between Mutual Funds And ETFs

Many ETFs are selected for the advantages of a particular index and can be managed passively for that reason, while mutual funds are often actively managed by a fund manager.

ETFs can be traded throughout the day. However, mutual funds can only be bought at the end of the trading day based on the value of the underlying assets. Since mutual funds are actively managed, fund managers make decisions about the underlying assets and liabilities. In general, this means mutual funds come with higher fees than ETFs.

Below is a closer look at some of the other differences between ETFs and mutual funds.

Benefits Of ETFs

The advantages of an ETF include the following.

• Tax-efficiency: In general, you will only realize a capital gain or capital loss when you sell the ETFs.
• Easy trading: You can seamlessly buy and sell shares of an ETF at any time throughout the day.
• Diversification: Since many ETFs are tied to an index, you can easily diversify your stock portfolio. For example, you might opt for an ETF based on the S&P 500, which would give you exposure to many different business sectors.

Disadvantages Of ETFs

Of course, there are also disadvantages to consider. The drawbacks include the following.

• Working with a broker: You’ll have to make your ETF purchases through a broker. Depending on the broker you choose, this can give your financial situation an added level of complexity.
• Market risk: As with any kind of stock market investment, you risk losing money in the market. If stock prices take a tumble, your portfolio’s value could drop dramatically.

Benefits of Mutual Funds

Investing in mutual funds also comes with advantages and disadvantages. We look at the benefits of mutual funds below.

• Diversification: Many mutual funds include a diverse array of underlying assets. This diversification provides some security for investors. 
• Convenience: Mutual funds are relatively easy to buy and tend to have low investment minimums.
• Liquidity: You can sell your mutual fund whenever you want to. But the trade won’t be executed until the end of the trading day.

Disadvantages Of Mutual Funds

Mutual funds have several disadvantages. These include the following.

• Fluctuating returns: The stock market is inherently volatile. With that, you can expect your returns to change over time. Profit is never a sure thing.
• Management: In most cases, actively managed portfolios tend to underperform the market. With that, opting for an actively managed mutual fund might not be the most effective choice.
• Capital gains: Mutual funds tend to generate more capital gains for shareholders. When the underlying securities are sold for a profit, this forces investors to realize a capital gain on their tax return.

FAQs About EFTs And Mutual Funds

You have questions about ETFs and mutual funds. We have answers. But if you want more help, get familiar with the basics of investing for beginners.

Why should I choose an ETF over a mutual fund?

ETFs tend to have lower expense ratios than mutual funds. Additionally, the passive management style of an ETF tends to offer a way to keep pace with market returns. If you’re looking for a low-cost and straightforward way to build an investment portfolio, ETFs are a good choice.

Are ETFs cheaper than mutual funds?

In general, ETFs are more affordable than mutual funds. Not only do ETFs usually have lower expense ratios, but also the minimum investment requirement is usually lower. However, there are always exceptions, which means you should take a close look at the numbers before moving forward.

Are ETFs good long-term investments?

ETFs are a worthwhile choice for long-term investors. Many ETFs are a good long-term investment. But it’s important to consider the risks of a particular ETF before deciding to hold it for years or decades.

Is it better to invest in mutual funds or ETFs?

Both mutual funds and ETFs have advantages and disadvantages that may make them the best choice in certain situations. Weigh the pros and cons of each type of investment or talk it over with your trusted financial advisor to decide what makes the most sense for your specific investment goals.

For example, investors concerned with tax-efficiency and lower expense ratios might prefer ETFs. But investors who prefer an actively managed option may find what they are looking for in a mutual fund.

The Bottom Line

ETFs and mutual funds each offer opportunities to investors. However, each comes with its own set of drawbacks to consider. Take the time to weigh your options carefully and consider talking through your goals with a financial advisor before moving forward.