Index mutual funds and their corresponding ETF’s are very similar in terms of their holdings. So how do you determine which one is best? We have to consider fees, taxes, how they are traded, among other things, to determine which is better. Like most things in personal finance, the decision will ultimately come down to your personal situation and preferences.
One of the major benefits of mutual funds, especially for younger investors, is the ability to set up automatic contributions. Typically, there are no fees associated with your regular contribution into a mutual fund. However, if you’re buying an ETF on the market, you may have to pay your broker a transaction fee each time. With any security you’re buying on an exchange, you also run into the implicit cost of the bid-ask spread.
Another benefit of mutual funds is the ability to purchase fractional units to invest every penny, compared with having to purchase whole shares which leaves cash leftover when buying ETF’s.
Mutual funds and ETF’s are traded differently. Mutual funds are traded at the end of each day at their Net Asset Value (or NAV). ETF’s are traded all throughout the day, so if you purchase the ETF at noon, and markets significantly rise or fall throughout the rest of the day, your noon price is locked in.
Mutual funds are structured in a way that requires the fund company to keep records for you. They have higher MER’s than ETF’s as a result but this record keeping may also save you time and frustration come tax-time if your investments are in non-registered taxable accounts. That being said, ETF’s are inherently more tax efficient. While their tax reporting may be more complex, the amount you have to pay as a result is lower.
Finally, ETF’s are generally more transparent as the individual security holdings are listed on the providers’ website and updated daily. Mutual fund holdings only have to be listed quarterly, so those holdings could change significantly over the course of 3 months. However, if it’s an index mutual fund, there likely won’t be much difference between the holdings when compared to an ETF.
Watch my video for more details around the difference between index mutual funds and ETF’s.
