Invest in ETFs or Mutual Funds?
Should You Invest in ETFs or Mutual Funds?
Diversify, diversify, diversify. Whatever stage of investing you’re at, you’ve likely heard it before. But what does this mean, and how can you achieve it? One way is by investing in different types of funds. Two of the most common types of funds are exchange-traded funds (ETFs) and mutual funds.
ETFs and mutual funds are two types of funds. At large, a fund is made up of various stocks and other assets, often tracking a common index. However, ETFs and mutual funds behave differently from one another.
Let’s pull the cover off of ETFs and mutual funds so you can decide where they fit (or don’t fit) into your investment strategy.
Investing in ETFs at a glance
What is it? An ETF is a basket of securities that tracks an index. It trades on an exchange during open market hours, much like a stock.
The details:
- ETFs can contain stocks, bonds, commodities, futures, and other securities.
- ETFs can be passively managed (solely tracking an index) or actively managed (regularly adjusted by a portfolio manager). FYI: Active ETFs try to outperform the market—sometimes succeeding, sometimes not—but passive ETFs tend to have lower fees.
- An ETF fee is measured by its “expense ratio.” In 2021, the average index equity ETF expense ratio was 0.16%.
Examples:
When an ETF might make sense in your portfolio
ETFs offer built-in diversification. However, many are also thematic—meaning you can still customize your investment strategy to fit your unique needs. A thematic ETF follows a bespoke index that can track anything from high-dividend stocks to consumer staples, from renewable energy to cryptocurrency futures and beyond.
If you want to take diversification literally and focus on the broad market, you can do that too—investing in major indices like the S&P 500, Dow Jones Industrial Average, and Nasdaq Composite.
Since ETFs trade throughout the day like stocks, they offer a level of liquidity other types of index funds do not. For highly involved investment strategies, this is a big perk.
Through brokerages like Magnifi, you can also invest in most ETFs through fractional shares. This allows you to start small, investing just a few dollars rather than buying an entire share. Through fractional ETF shares, you can build up your portfolio over time. According to a recent Magnifi study, more than a fifth (21%) of investors think you need $1,000 to start investing—but today, that can’t be further from the truth.
When should you avoid an ETF?
Since most people adopt their own hybrid investing model that suits them, there’s no one red flag for a particular investment. However, it’s important to consider factors that may turn you off, like ETFs with high expense ratios whose returns don’t make up for it, or ETFs in risky sectors you’re not confident about.
By assessing your investment strategy, you can create your own hard lines in the sand. Use Magnifi Personal, a natural-language AI investing assistant, to search queries like “ETFs with low expense ratios,” “low risk robotics ETFs,” and anything else that comes to mind.
Investing in mutual funds at a glance
What is it? A mutual fund pools money from shareholders to invest in diversified securities. Prices do not fluctuate and trades are settled at the end of each trading day.
The details:
- Mutual funds can contain stocks, bonds, commodities, futures, and other securities.
- They can be passively managed or actively managed by money managers.
- On average, mutual funds tend to have higher expense ratios than ETFs. In 2021, long-term mutual funds had an average expense ratio of 0.47%.
Examples:
- Vanguard Total Stock Market Index Fund (VTSAX)
- American Funds EuroPacific Growth Fund® (AEPGX)
- T. Rowe Price Blue Chip Growth Fund (TRBCX)
When a mutual fund might make sense in your portfolio
Mutual funds also offer built-in diversification, and there are myriad options to choose from on the market today. Pricing for mutual funds tends to be more stable than ETFs because they’re only priced once per trading day. This can help investors of all kinds create a solid foundation for their portfolio without the risk of pricing fluctuating throughout the day.
That’s not to say there’s no risk involved in mutual funds (most investments carry some level of risk—that’s just the name of the game). However, mutual funds tend to align more with broader market trends than, say, thematic ETFs.
While many mutual funds do have a minimum buy-in, others are available for as little as a buck a share. Magnifi also offers fractional shares for some popular mutual funds, expanding the low-cost investor’s repertoire.
When should you avoid a mutual fund?
Whether or not mutual funds as a whole are right for you, or whether some may suit you better than others, depends on your strategy and the goals you hope to achieve through investing. Consider factors like expense ratios, historical rate of return, and underlying assets.
Write down your strategy and research mutual funds that do (and don’t) meet your terms. Consider inquiring about “conservative hybrid mutual funds,” “regional mutual funds with global exposure,” and any other search that fits the bill.
How ETFs and mutual funds can complement each other in a diversified portfolio
In the ETF-versus-mutual-fund debate, the reality is that it’s not an either-or scenario. You have the capability to invest in both types of index funds, as well as other securities, to create a robust and diversified portfolio.
For example, you may choose to invest 20% of your portfolio in ETFs, 20% in mutual funds, 10% in individual stocks, 10% in bonds, and 40% in real estate. This is just a sample, and your portfolio may look way different. That’s okay! What matters is that you can make educated decisions that work in your favor.
For many investors, diversification is an ongoing process. With Magnifi Personal, you can get tailored recommendations to broaden your exposure for your retirement savings or other life goals. On the Magnifi platform, you can also search for specific ETFs and mutual funds based on factors like:
- Active vs. passive
- Low expense ratio
- Outperformance
- Sector (aka industry)
- Geographic location (such as USA or international)
- Market capitalization (such as large cap, mid cap, or small cap)
- Bonds, commodities, and other types of assets outside of stocks
- ESG (focused on environmental, social and governance criteria)
- & more
Then, you can quickly act on those recommendations if you choose to, knowing that the choice is, ultimately, yours.
References:
- Mutual Funds and Exchange Traded Funds (ETF’s) are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from the Fund Company or your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.
- “Trends in the Expenses and Fees of Funds, 2021” Investment Company Institute, March 2022, https://www.ici.org/system/files/2022-03/per28-02_2.pdf.
- Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk.
- “Trends in the Expenses and Fees of Funds, 2021” Investment Company Institute, March 2022, https://www.ici.org/system/files/2022-03/per28-02_2.pdf.
Disclosures:
All content is for information purposes only. It is not intended to provide the basis for any financial decisions. Investing always involves risk and possible loss of capital.
Advisory services are offered through Magnifi LLC, an SEC Registered Investment Advisor. Being registered as an investment adviser does not imply a certain level of skill or training. The information contained herein should in no way be construed or interpreted as a solicitation to sell or offer to sell advisory services. This material has been derived from sources believed to be reliable but is not guaranteed as to accuracy and completeness and does not purport to be a complete analysis of the materials discussed.
Purchases are subject to suitability. This requires a review of an investor’s objective, risk tolerance, and time horizons. All information and ideas should be discussed in detail with your individual adviser prior to implementation.