How Do ETFs Compare to Mutual Funds?

Copy adapted from RBC Global Asset Management's article "An investor-friendly guide to mutual funds and ETFs".

Mutual funds and exchange-traded funds (ETFs) are both excellent tools for building a diversified investment portfolio, but they operate in slightly different ways. Understanding these differences can help you make more informed decisions — it all depends on your goals, preferences and circumstances.

Similar goals, different mechanics

Both mutual funds and ETFs aim to give you access to a diversified basket of securities, such as stocks or bonds. This diversification helps reduce concentration risk. However, there is a difference in how the two trade:

• Mutual funds: Trades are typically executed once per day, after the market closes. The price is based on the fund’s net asset value (NAV), which is calculated at the end of the trading day.
• ETFs: These are traded throughout the day on an exchange, just like individual stocks. Prices fluctuate in real-time based on market activity and the value of the underlying holdings.

ETFs offer flexibility for investors who want to take advantage of intraday price movements. Mutual funds, on the other hand, offer an end-of-day pricing approach.

Active or index-tracking? The choice is yours
A common misconception is that ETFs are always passive, index-tracking investments, while mutual funds are exclusively actively managed. In reality, both vehicles can adopt either strategy:

• Active management: Aims to outperform a benchmark or achieve a specific goal by strategically selecting securities.
• Index-tracking: Aims to replicate the performance of a specific benchmark or index.

For example, there are actively managed ETFs designed to deliver higher returns than their benchmarks. There are mutual funds that simply track an index. When deciding between active management and index-tracking, it’s less about the type of vehicle (mutual fund or ETF) and more about your investment goals and risk tolerance.

Fees: not the whole story
There are two costs to consider when choosing one of these fund types: management expense ratios (MERs) and trading commissions. MERs for mutual funds tend to be higher, while MERs for ETFs tend to be lower. But it’s typically a good idea to compare comparables. Mutual funds traditionally have higher MERs because they are traditionally actively managed, but you can get a passive mutual fund and the fees will be lower, and you can get an actively managed ETF and the fees will be higher.

• Lower fees for index-tracking strategies.
• Higher fees for active ones.

Depending on how much you want to invest and your trading style, you may want to consider calculating how much trading commissions and MERs you may incur for the fund holding.

Which is right for you?
The choice between mutual funds and ETFs comes down to your individual goals, preferences and circumstances. Both offer valuable ways to build a diversified portfolio. Both can be tailored to fit your needs. When evaluating your options, consider factors like management style, fees, overall performance and trading flexibility. By understanding these differences, you’ll be better equipped to make informed investment decisions and achieve your financial goals.

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> Next: How ETFs are Created: A Deeper Dive

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