“Probably the number-one misconception is that it’s about ETFs versus mutual funds. We don’t like to make it a ‘versus’ discussion because we don’t think one is inherently better,” said Jim Rowley, senior investment analyst for Vanguard Investment Strategy Group. “We offer both ETFs and mutual funds at Vanguard, and believe each can serve a purpose together in investors’ portfolios.”
Even in the areas where ETFs and mutual funds differ in terms of specific attributes, one could argue the most basic and compelling benefits stem largely from the benefits of the pooled investment structure and the shared regulatory environment that both are governed by.
“Both mutual funds and most ETFs are governed under the same regulatory standard, the U.S. Investment Company Act of 1940,” said Mr. Rowley.*
So if they’re more similar than different, how do you decide between an ETF or mutual fund? There are four key questions that can help you determine which one is better for your unique circumstances.
A good place to start is to determine what you’re trying to accomplish with the ETF or mutual fund. The decision could be as simple as determining whether you’re trying to invest in an index fund or an active fund.
1. What is your investment strategy?
From an investment strategy perspective, an overwhelming number of ETFs are indexed, and an overwhelming number of mutual funds are actively managed. So investors who are looking to index might prefer ETFs. Conversely, investors looking for actively managed investments may find mutual funds offer more choices to meet those needs.
2. How much trading flexibility do you want?While the daily liquidity offered by mutual funds—once at the end of the trading day—is sufficient for many investors, ETFs offer greater control over timing and price. This is because ETFs can be traded throughout the day, just like stocks, when the market is open. Investors who specifically value this trading flexibility may find ETFs more appealing than mutual funds. Otherwise, this factor maynot be a significant consideration for investors who don’t want or need intraday liquidity.
Depending on which brokerage account platform you’re using, your options for purchasing a particular mutual fund can vary, and sometimes widely. This is because a mutual fund company must first enter into an agreement with broker-dealers to offer a company’s funds on a brokerage platform.
3. How accessible are your fund options?
In contrast, because ETFs trade on exchanges, just like stocks, they’re more accessible. Any investor with a brokerage account can buy or sell virtually any ETF.
“It’s not unlike the difference between purchasing a book from your local bookstore or going online. Your access is restricted by what’s available on the store shelf. You might find more options online. There are tradeoffs to both options,” said Mr. Rowley.
It’s not uncommon to hear that cost should be the starting point for determining whether to go with an ETF or mutual fund, but we think this should be factored in only after you consider investment strategy, trading flexibility, and accessibility. Going through the decision process in this order can improve the likelihood that your decision matches up with your long-term investment goals.
4. Which fund option is more cost-effective?
There are various ways to determine whether ETFs or mutual funds are more advantageous from a cost perspective. ETFs and mutual funds are subject to two main types of costs, transaction and ongoing. It’s not dissimilar from the decision to buy or rent furniture, which can involve a cost calculation that considers how you intend to use the furniture. Similarly, when choosing between a mutual fund and an ETF, consider more nuanced aspects such as ongoing and point-in-time transaction costs:
- Transaction costs occur at a point in time and include things such as bid-ask spreads and upfront fees or commissions. Vanguard ETFs® trade commission-free in a Vanguard Brokerage Account.
- Ongoing costs occur gradually over time and include things such as expense ratios and taxes.
In addition, the decision whether to invest a lump sum or make ongoing investments may affect the choice between ETFs and mutual funds.
“If an investor is making regular investments in a fund, such as every two weeks or every month, then mutual funds may be a better choice, because mutual funds can generally facilitate automatic investment in a more efficient manner,” Mr. Rowley said. “If, however, you’re investing a lump sum, and intend to hold the investment for an extended period of time, then you might benefit from taking a closer look at the all-in costs to see which side of the breakeven point an ETF or mutual fund might fall on.”
Choosing between ETFs and mutual funds may obscure an important point—these products are really more similar than different.
Key similarities can outweigh the differences
For investors who prefer a greater variety of index-based strategies, the ability to trade intraday with various order types, and more open fund access, ETFs may be the better choice. However, for investors who want a greater variety of traditional actively managed strategies, the trading convenience of mutual funds, and the breadth of mutual funds available on their trading platform, mutual funds may be preferable. Expenses include both ongoing costs and transaction costs, and may depend largely on the time horizon of the investment.
Making a choice between ETFs and mutual funds may require a test drive through the decision process. We have tools to help you. Both ETFs and mutual funds can help you achieve your investment goals and, in the end, you should be happy with what you drive off the lot.
*Mutual funds and most ETFs are regulated by the U.S. Investment Company Act of 1940, which requires funds to hold liquid assets, constrains the use of leverage, and provides transparency to investors through mandated prospectuses and annual reports.
All investing is subject to risk, including the possible loss of the money you invest.
Past performance is not a guarantee of future results.
You must buy and sell Vanguard ETF Shares through Vanguard Brokerage Services (we offer them commission-free) or through another broker (who may charge commissions). See the Vanguard Brokerage Services Commission and Fee Schedules on Vanguard.com for limits. Vanguard ETF Shares are not redeemable directly with the issuing Fund other than in very large aggregations worth millions of dollars. ETFs are subject to market volatility. When buying or selling an ETF, you will pay or receive the current market price, which may be more or less than net asset value.