Mutual funds and ETFs are two popular investment vehicles that allow investors to access a diversified portfolio of stocks or bonds. While they share some similarities, there are key differences between the two that investors should be aware of. One major difference is how they are traded.
ETFs trade like individual stocks on an exchange, with prices fluctuating throughout the day. In contrast, mutual funds are bought and sold directly through the fund company at the end of each trading day. Fees are another important distinction.
ETFs typically have lower expense ratios compared to mutual funds. The median expense ratio for ETFs is 0.52%, while it’s 0.91% for mutual funds, according to State Street. Over time, these lower fees can result in higher net returns for investors.
Mutual funds often have minimum investment requirements, whereas ETFs can be purchased for the price of a single share. This makes ETFs more accessible to a broader range of investors. Professional money managers at prominent investment firms manage both mutual funds and ETFs.
These experts handle the complexities of portfolio management, making it easier for individual investors to own a diversified set of assets without needing to actively manage them. When it comes to investment strategy, well-known market commentator Jim Cramer suggests beginners invest their first $10,000 into an S&P 500 index mutual fund or ETF. He cautions against holding too many individual stocks, recommending no more than five.
Cramer emphasizes the importance of “buy and homework” rather than just “buy and hold.”
Ultimately, the choice between mutual funds and ETFs depends on factors such as trading flexibility, costs, minimum investment requirements, and personal investment goals. Investors should carefully review fund prospectuses to understand the investment objectives, risks, fees, and historical performance before making a decision.
Differences in trading and fees
The ETF market has experienced significant growth in recent years, with a record 723 new funds launched in 2024 alone. This growth has attracted high-profile economists and investors looking to capitalize on the trend. However, starting an ETF is no easy feat.
It requires significant upfront costs, including SEC filing fees that can range from $50,000 to $500,000. There are also ongoing expenses, such as staff salaries, compliance, marketing, and office overhead. Morningstar analyst Zachary Evans estimates it can cost around $200,000 per year to run an ETF.
To be financially viable, ETFs must accumulate a substantial amount of assets under management (AUM). The fees they earn, known as expense ratios, are based on a percentage of the assets under management (AUM). So the more assets a fund has, the more revenue it generates.
Performance is also critical. A fund that delivers strong returns will see its AUM grow, leading to higher fee revenue. But performance alone isn’t enough to ensure an ETF’s survival.
Many new ETFs launch with seed money from initial investors who commit to keeping their capital in the fund for a set period, usually two to three years. If these investors pull out after that time and the ETF hasn’t attracted enough additional investment, it can spell trouble for the fund. Fund closures have become increasingly common as more firms enter the ETF space.
Over 200 ETFs shut down in 2023, and just under 200 closed in 2024. “The vast majority have really failed to catch on with investors,” said Evans. They’ve failed to generate either the performance or the asset level to support these products.
As famed investors and analysts continue jumping into the ETF market, it remains to be seen which funds will be able to stand out and attract the assets necessary for long-term success in an increasingly crowded field.