The Shakedown: ETFs vs Mutual Funds

Quote

“Expectations can rise faster than income, so a higher income sends expectations spiraling out of control.” - Collaborative Fund

ETFs vs Mutual Funds

“You should buy ETFs.”

“Mutual funds are a bad investment.”

“Index funds have proven returns.”

Wait…so what is what?!

Good question. In the investing world these terms are often mixed up and used incorrectly.

To help you out, below are seven ways that ETFs are different from mutual funds, how index funds fall into these, and an example to make it all clear as mud.

Let’s get into these seven points so you can impress your co-workers next time they start throwing around mutual fund and ETF in the same sentence.

1) Trading

ETFs are exchange traded and can be traded during normal market hours like a stock.

Mutual funds can only be bought or sold once per day after the market closes.

2) Tax Efficiency

Since you own the ETF shares, you only incur capital gains tax when you sell.

With mutual funds, the manager must sell shares anytime one wishes to remove their cash. When sold for a gain, this tax is passed onto every investor in the fund.

In short, ETFs are a bit more tax efficient. Here’s an article going into more detail on the tax differences if interested: Investopedia: ETF vs Mutual Fund Taxes.

3) Initial Investment

ETFs have no minimum besides the share price. If using a brokerage with fractional shares it’s as low as $1 (Fidelity, Vanguard, M1 Finance, Robinhood).

Mutual funds require a high minimum investment. For example, Vanguard requires a $3,000 initial investment to invest in their popular VTSAX index mutual fund.

Something to remember, especially for those just getting into investing.

4) Transparency

ETF holdings are shown on a regular basis and sometimes even daily.

Mutual funds reveal their holdings quarterly with a 30 day delay.

PS. On the note of being transparent, here is a recent post revealing my top 5 ETF holdings.

5) Option Chains

ETFs with large amounts of volume will have liquid option chains. For example $SPY and $QQQ.

For most long term investors this will not make a big difference. For those who potentially want to sell options on their holdings, ETFs would allow you to do so assuming the ETF has a liquid option chain.

Mutual funds do not have option chains.

6) Share Price:

(Irrelevant if you have access to fractional shares)

With ETFs you have to buy at the share price like a normal stock.

Mutual funds can be bought in any dollar amount and the purchase can be automated. The automated buys of mutual funds is a plus. If you want to invest 100% passively then #6 is a win for mutual funds.

7) Holdings

If both are tracking the same index the two will have similar holdings.

The difference between a S&P 500 mutual fund and ETF isn’t going to be much.

Which is an Index Fund?

To make this as short as possible.

Index funds can be mutual funds or ETFs. “Index” simply refers to a fund wanting to track the return of a common market (ex the S&P 500).

So, you can have an S&P 500 index mutual fund, and a S&P 500 Index ETF.

All index funds are mutual funds, but not all mutual funds and ETFs are index funds.

Example

Let’s compare VTSAX and VTI.

VTSAX is Vanguard’s total stock market index mutual fund.

VTI is Vanguard’s total stock market index ETF.

These both contain the same stocks and will have essentially identical returns. The only differences are the ones mentioned above.

Clear as mud? Great. Here is one last thing to remember.

When investors mention index funds 99% of the time they are referring to mutual funds like VTSAX. This can be confusing as VTI is also technically an index fund inside the shell of an ETF.

What’s Better?

Both are outstanding options.

My favorite is index ETFs but that’s nothing against mutual funds.

Take in the factors above, decide what’s best for you, and get started. Compound interest doesn’t wait and time marches on.

Thanks for reading my friend, I’ll catch you in the next one. ~ Cade

Cade's Finds

Americans Have Never Been Wealthier & No One Is Happy - Net worth of households is up 37% from 2019, but it doesn’t feel like it. This post by Ben Carlson has great visuals showing the results of the Federal Reserve Family Finances report. This only comes out every three years so check it out.

Covert Marketing Methods - Fun podcast discussing some great marketing examples throughout history. Everything from how women started smoking cigaretts to how orange juice became the go-to breakfast drink.

2024 Retirement Account Limits are Increasing - If you needed some good news today, IRA and 401k limits are going up in 2024. We’ll scratch that down as a win for the home team.

Best Memes

Index funds (whether mutual funds or ETFs) are the way.

Not a meme, but this is too accurate.

Nothing in this email is intended to serve as financial advice. Do your own research. Thanks for reading, if you have any questions, comments, suggestions, etc. about the email don’t hesitate to send me a reply.