What’s the Difference between Mutual Funds and ETFs?

What would you like Sir?  More Diversification?  Coming right up!

waiterlid

Mutual Funds & ETFs offer the same thing for investors…Lots of diversification assets within a single purchase.  Each contain a basket of stocks to spread out risk instead of individuals (you and me) buying hundreds if not thousands of stocks to reduce our risk.  There are distinct differences between the two, however, like the long term costs associated with them.  Let me explain each:

Mutual Funds


Mutual Funds are an investment that most of you will be familiar with if you have a 401K plan or an Individual Retirement Account (IRA).  The majority of 401Ks today are built with a collection of mutual funds that your company has selected through a provider on your behalf.  Mutual funds are a basket of stocks (ranging from hundreds to thousands) that a fund manager has strategically selected to diversify risks.  This is done to provide individuals a balanced portfolio to make it harder to ruin a life of savings.  Balanced portfolios reduce potential risk by having stocks from different asset classes and sectors.

Examples of mutual fund companies would be T.Rowe Price, Vanguard, and Fidelity.  Mutual funds generally reflect major stock indexes, like the Dow Jones Industrial Average and the S&P 500, or several variances of them.  Again, the benefit of using an investment choice like a mutual fund is that it spreads out the risk for the end investor.  As a general rule of thumb, I stay away from Mutual Funds because there is a much better alternative called ETFs (Exchange Traded Funds) that are very similar to use in your portfolio.

ETFs


Exchange Traded Funds (ETFs) are the better looking cousin to mutual funds and act in the same manner as a mutual fund, as it pertains to a basket of stocks.  Why is that, do you ask?  Well, ETFs are very similar to mutual funds with comparable compositions.  They are constructed to spread out risks by investing in a basket of stocks that is selected by a fund manager.  The basket of stocks can at times mirror major indexes like the S&P or Dow Jones Industrial Average or selected industries.  But still, why are they the better looking cousin?

Here’s where you want to pay close attention

The hidden secret on mutual funds is the amount in fees that are charged.  You may tell yourself that 1.0-3.0% or less isn’t much for a mutual fund to charge, but what if I told you the average person investing in mutual funds can spend over $150,000 through their life in mutual funds fees.  WOW!  This number is factored with compound interest over time and could have been earned instead of given away.  Now that I gave you a much bigger number to work with, you may reconsider giving away that 1-3% to a mutual fund or a financial advisor.  ETFs charge a fraction of that to provide customers with a similar balance of risk in the neighborhood of .25% and offer the same type of returns.  The best part?  You can trade ETFs like stocks (meaning you can get in and out whenever) versus Mutual Funds that typically require a 30-90 day restricted selling period, from the date of purchase (meaning you can’t sell early without a penalty).

Here’s why I really hate Mutual Funds, personally.  I used to have a Mutual Fund account.  I bought into new International Currency Fund that had a management team with a very high track record.  The fund was supposed to be a stable part of my portfolio and had over 10% of my total holdings.  Within 25 days of my purchase of the fund, the price dropped 15%.  I was stuck.  I couldn’t sell it for 60 days without incurring a penalty, but I didn’t want to keep losing more money.  It cost me a 3.5% early redemption fee to sell.  I had to get rid of it and incurred an almost 20% loss because of Mutual Fund provisions.  10 days later, the fund dropped an additional 10%.  I’m glad I got out when I did.  After this I took all my money out and quickly got into a brokerage account without these restrictions.

So, who do I look to for a great service?

question-mark

There are literally thousands of ETFs to choose from in today’s stock market, so I’ll suggest my favorites.  There are three major players when it comes to Mutual Funds in today’s economic landscape – Vanguard, T. Rowe Price, and Fidelity.  There are hundreds if not thousands more, but these three are some of the top dogs when it comes to assets and longevity.  There is one that I recommend above the others because they are the low cost provider when it comes to Mutual Funds and ETFs.

Vanguard has long been the low cost provider and has a vast amount of knowledge.  Also, they were the first to the front of the line to establish ETFs, and do a great job of mirroring their professionally managed mutual funds.  Vanguard’s investment teams have historically been performing at a high level for a long time.  Vanguard provides excellent options that are very easy to use and understand to help build the foundation of a portfolio.  You can open up an ETF-only account with free trades for $3,000 using their platform and purchase monthly (almost like paying yourself).  If the $3,000 scares you, go with my second favorite option with ETFs, which is Fidelity.  Fidelity also offers free trades on their iShares ETFs commission free with no minimum to start, which is very appealing.

Both options are extremely easy to use and I highly recommend them when starting your investment journey for financial freedom in today’s economic environment.

Alex Richwagen is an investment research analyst.  Any of his recommendations are that of Mr. Richwagen, the information presented by him is the opinion of his research.  All investment decisions are your choice and should be based on your own analysis.

3 thoughts on “What’s the Difference between Mutual Funds and ETFs?

  1. Okay Alex,

    You got me interested! However, would your recommendation still be the same if I am able to purchase Mutual Funds through Franklin Templeton at the net asset value and no time limit to sell. I like what you have researched and may do both….holler!

    Like

    • Hi Jeanette,

      Thanks for your question!
      Just off the fly, I googled Franklin Templeton and picked a mutual fund at random, here’s the link – http://bit.ly/1Lvw0lE
      On the right hand side is their sales commissions, here’s a copy

      Expense Ratio and Sales Charge As of 03/01/2015 (updated annually)

      Gross Expense Ratio5 1.09%
      Net Expense Ratio 1.09%
      Max Initial Sales Charge 5.75%
      CDSC 0.00%
      12b-1 Fee 0.30%

      Here’s one from Vanguard ETFs with the same expense breakdown on a similar “Balanced Fund” – http://vgi.vg/14WrUU5
      And the expenses –

      Expenses
      Total Stock Market ETF 0.05%

      Yes, that’s the complete listing of their fees.
      How to figure out your costs on this and how it could impact your earnings.
      Let’s say a typical mature portfolio has at least $100,000
      The expenses on Franklin Templeton with a Future value using 1.09% over 30 years = $35,735.81 (Keep in mind I didn’t include Sales Charges and the 12-b fees)
      The expenses on Vanguard ETF with a Future value using .05% over 30 years = $11,328.54
      That’s a difference of over $24,000

      Here’s a great side by side that also explains the difference of Mutual Funds and ETFs I found on Vanguard’s site – http://vgi.vg/1BGvi56

      I hope the quick analysis I provided above gives you the insight you are looking for to achieve your investment goals!

      Cheers!

      Alex

      Like

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s