If you are new to investing all the jargon can be a major turn off. Here are some simple ways to understand the differences between two investment options: Exchange Traded Funds (ETFs) or Mutual Funds.
ETFs and Mutual Funds have a lot in common:
Both ETFs and Mutual Funds are newbie friendly
Both ETFs and Mutual Funds offer a wide variety of investment options
Both ETFs and Mutual funds are less risky than buying individual stocks or bonds
And all these qualities make them excellent choices for newbie investors.
Instead of researching and purchasing individual stocks, both ETFs and Mutual Funds allow you to outsource the stock management by investing in a basket of stocks.
These 'baskets of stock' are managed by professional portfolio managers but there is a distinct difference between the two.
If you look at the grocery store as an example of the total stock market, you can look at a specific category like FRUITS and look to track all the components such as Apples, Oranges and Bananas. This would be the FRUIT ETF. However if you want someone to start picking the best Banana, the shiniest Apple and so on, that is akin to having a Mutual Fund portfolio manager make these picks for you in a Mutual Fund. Since you are paying someone to pick the best fruit for you, you will also be paying a higher fee.
The difference in fees between an ETF and a Mutual Fund is the most discussed difference - and for a good reason. ETF fees on average are one-third of the fees paid for Mutual Funds. If you look at the cheapest ETF, the gap is even higher.
For example the management fee for VTI (Vanguard Total Stock Market ETF) is 0.04% which means you pay $4 for every $10,000 you invest. In contrast, the Scotia US Equity Fund - Series A has a management fee of 2.22% which means you pay $222 for every $10,000 you invest.
Over time this can add up to a material difference so it is important to look at the cost and management fee.
The other key difference for a newbie investor is that Mutual Funds usually have an initial investment minimum (from as low as $500 to as high as $3,000) to get started. Future investments can be lower ($25 and up) once you are set up. However if you don't have $500 lying around to invest, then an ETF is ideal. There are no investment minimums for ETFs and you only need the funds to purchase one ETF (can be as low as $25).
There is a reason that both ETFs and Mutual Funds still exist however. In some cases the performance and the advice received when buying a mutual fund can be worth the fee. It is most critical to be an educated investor and make an active decision on which of the two are best for you.
Here is a quick summary of the differences between an ETF and a Mutual Fund
| ETF | Mutual Fund |
Fees (Avg) | Avg ~0.5% | Avg ~1.5% |
Minimum Investment Amount | Cost of one unit for that ETF (VTI is currently trading at $240, ICLN is $23.84) | Ranges between $500 and $3,000 |
Flexibility | You can buy and sell an ETF in real time just like a stock. | Mutual Funds have to be purchased or sold at the end of day price. |
Proceeds from sale | You will receive funds immediately after sale during trading hours | If you are looking to sell it can take up to 24 hours to receive your cash |
Learn more about investing and how to get started here
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