ETFs vs Mutual Funds: Learn The Pros & Cons

Benefits of mutual funds

When you purchase shares in a mutual fund, you’re adding your money to a large pool of invested funds. Most mutual funds let you invest in a wide range of stocks and bonds. There are mutual funds to meet every investment need: younger investors could benefit from a growth fund with a higher percentage of equities, since they have more time to ride out the swings in the market, while older or retired investors might choose a bond fund that focuses on providing income. There are mutual funds that are index-based and others that are actively managed. This makes their fees a bit higher, but you get the benefit of knowing that a professional manager has made the decisions about which stocks or bonds are held in the fund.

Benefits of ETFs

ETFs are usually managed automatically, based on a computer algorithm that tracks the performance of the market or sector the fund is focused on. ETFs tend to be passively managed: Since they mirror the market’s performance, managers are not concerned with picking the winners and beating the market. This means that management fees and expenses for investors are often low, sometimes as little as 0.25% of your investment. This makes ETFs a great choice for savvy investors. If you’re just getting started with investing, but want to make sure you’re getting the benefits of a diverse portfolio, an ETF could be a good choice. Your first ETF purchase can be a single unit with costs varying, typically around $20-50.

How are they similar?

Most ETFs and mutual funds are set up to track a specific market or sector, and both hold a wide range of investments within that sector. They’re a convenient way for an individual investor to hold shares in many different companies, invest in companies from a single country or invest in companies that support a worthwhile cause, all with a single investment.

If you’re saving for retirement, ETFs and mutual funds can both be held within RRSPs and TFSAs. After cash (55%), mutual funds are the most popular investment within TFSAs: nearly one-third (32%) of TFSAs included mutual funds in 2018, but only 10% of TFSAs included ETFs. Many more Canadians hold investment products within their RRSPs. More than half (55%) of all Canadians hold mutual funds in their RRSP, and 14% hold ETFs in their RRSP. ^{footnote 11}

How are ETFs and Mutual funds different?

In addition to lower management fees, ETFs often have low turnover rates in the assets that they hold within the funds. This means ETFs have relatively lower capital-gains tax liabilities than other investments, especially when compared to equity-based mutual funds. In short, ETFs offer two advantages over mutual funds: they cost less, and they can be more tax efficient. An additional benefit is the trading flexibility ETFs offer: since they are traded on an exchange, you can choose what price you buy and sell at.

However, depending on how you choose to invest in ETFs, there may be higher transaction costs and commission fees. Be sure to research the fees that may be associated with your trades.

Still not sure what’s the right call for your investments? Your investment professional can help you learn how ETFs and mutual funds (or both!) can help you reach your financial goals.