How Do ETFs Compare to Mutual Funds?

Picture this: You're looking at paint samples trying to choose the perfect colour for your walls. Now imagine two scenarios. In scenario one, you're trying to decide between Punch of Fuchsia and Soothing White. In scenario two, between Soothing White and Calming White. You'd probably have an easier time making a pick in the first scenario than the second.

The more similar things are, the more challenging it is to suss out which one is right for you. Over the years, ETFs and mutual funds have become increasingly similar, making it challenging for some investors to decide which fund type best suits their needs. ETFs and mutual funds both hold a basket of assets, offer instant diversification, are relatively easy to buy and sell and can complement a wide range of investment strategies. But, says Tony Matos, CIM, RBC Direct Investing Relationship Manager, they're structured differently.

The difference between ETFs and conventional mutual funds is the way units of each are bought and sold. Like individual stocks, ETFs are listed on a stock exchange and can be traded throughout the day. Mutual funds, meanwhile, are purchased and sold through an investment or mutual fund dealer at the end of each trading day. With ETFs, you would enter the specific number of securities you want to buy or sell. With mutual funds, you would enter a set dollar amount and your trade would remain pending until the fund's net asset value is calculated at the close of trading.

What does this mean for you? Matos breaks down the key considerations for investors.

1.Transparency

What's in that “basket" of assets? “With ETFs you have complete transparency," says Matos. In a passive ETF, the underlying assets track the benchmark, whereas with an active ETF, the assets change and they are disclosed daily. “So you can see exactly what the holdings are, what the prices of those holdings are on the market, how they're being traded, how many times they have been traded on any given day," says Matos. “With a Mutual Fund, typically, you see a full listing of holdings on a quarterly basis. So the fund manager could have sold a lot of positions that you thought you were getting exposure to, and you wouldn't find out until after quarter-end when the report is filed."

2.Control

To Matos, the most important question is: How much control do you want? The transparency of an ETF, combined with the way it trades, means you can keep an eye on your investment and easily make changes if and when you see fit.

3.Cost

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 Matos cautions against comparing apples to oranges. “To some extent, you get what you pay for. 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." Compare comparables. And in every case, do the math for your specific situation, says Matos. Depending on your investment amounts and trading style, you can consider calculating how much trading commissions and MERs you may incur for the fund holding.