Mutual funds remain Canadians’ favourite investment. It is estimated a trillion dollars sits in mutual funds in the country.
Although Exchange-Traded Funds – ETFs- have been introduced in the late 80’s, they have only started becoming increasingly popular a few years ago.
Mutual funds and ETFs are a bit like cousins. They share a few common traits but are actually very different.
|definition||An investment vehicle that is made up of a pool of funds collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and similar assets.||An exchange traded fund is a marketable security that tracks an index, a commodity, bonds, or a basket of assets like an index fund.|
|Management style||Usually active; Fund managers tries to outperform the market/index. Rebalancing portfolios is common||Usually passive; an ETF merely tries to replicate the index it is tracking. Rebalancing is seldom necessary.|
|Management fees (MER/TER)||Usually on the high side, as mutual funds are actively managed.The MER directly impacts the fund’s return.||On the low side, due to the passive approach.|
|Other fees||Mutual funds are notorious for carrying various fees such as trailer fees, switch fees, redemption fees, sales charges etc….||Trading fees paid to broker|
|Risk||Both products have a similar risk level. You can lose or make money.|
|Unit value||Calculated at the end of the day||Varies throughout the day as ETFs are listed on stock-exchanges|
|Buying||Most MFs require a minimum amount for buying. Some also require additional contributions.||No minimum required but need to buy “in bulk” or “lump sum”. Some brokers charge additional fees for low volumes.|
|Selling||Cash||In-kind. Investors usually exchange their units.Cash is possible, but usually at a discount|
|Dollar cost averaging/monthly contributions||Yes||No, because of the trading fees|
|Tax efficiency||Usually lower||Usually higher|
ETFs are cheaper and more transparent. Investors know exactly what they are getting. Their downside is that they are more for people with larger amounts of cash available. They also have a more long-term range, because of the “in-kind” consideration and the trading fees.
Most mutual funds are expensive and very few outperform their indexes. But, they are a good starting point for the beginner investor and for people who don’t necessarily have tons of cash.
Some funds are specifically targeted at D.I.Y investors with lower fees. Others also start having a more passive approach and actually generate decent results.
Just like any financial product, do your own research before investing. Don’t just look at the amount of fees you may be paying –or not- or the return. You need to understand what you are buying into.