ETF vs mutual funds: Which should investors choose?

If you’ve been investing for a while, you’ve likely come across both exchange-traded funds (ETFs) and mutual funds. Maybe you already hold a few of each in different accounts. At first glance, they seem similar. Both give you exposure to a diversified basket of assets. Both can include stocks, bonds, or other securities. But how they work behind the scenes is very different. 

In this article, Wealth Professional Canada will compare ETFs vs. mutual funds. We’ll focus on what really separates the two, such as the pros and cons, and the types of investors best suited for each. We’ll also discuss important points to consider when investing in mutual funds. 

To our usual pool readers who are financial advisors and wealth professionals, this article is one of our client education pieces. Feel free to share this with your clients, especially those who are interested in ETFs, mutual funds, or both. 

An overview of ETFs and mutual funds 

ETFs are investment products that trade on stock exchanges like regular shares. They pool money from investors to buy a mix of assets, such as stocks or bonds. Most ETFs track a market index, but some are actively managed. Their prices change throughout the day, giving investors flexibility in how they buy and sell. 

Watch this video to better understand how ETFs work: 

Did you know that younger investors tend to invest in ETFs? They’re also “confident and self-reliant" according to this article. 

On the other hand, mutual funds also pool investors’ money to create diversified portfolios. However, they don’t trade on exchanges. Instead, they are priced once a day based on the fund’s net asset value (NAV). 

Fund managers actively adjust the holdings to meet performance goals. While mutual funds offer professional management, they often come with higher fees and less control over when trades are made. 

Watch this video to know more about investing in mutual funds in Canada: 

If you’re still new to investing, you might want to check out this guide to mutual funds for beginners. 

ETFs vs. mutual funds: What’s the difference? 

ETF somehow works like mutual funds, but they differ in some aspects, such as: 

Management  

Exchange-traded funds can be passively or actively managed by the fund managers and are linked to an index’s performance. Mutual funds are usually actively managed. Both come in active and indexed varieties.   

Trading 

Transactions or trades on mutual funds are made once a day, and investors receive the same price on that same day. On the other hand, ETFs are traded like stocks where they are bought and sold on the stock exchange. As such, ETFs fluctuate throughout the day.  

Minimum investment  

Since ETFs are traded like stocks, there is no minimum investment required. You can even purchase an ETF for the price of one share, which is known as the market price. On the other hand, mutual funds require initial investments at a flat dollar amount, and shares can be purchased in fractional shares.  

Costs  

The most surprising difference between the two is the cost. ETFs come with implicit and explicit costs. Mutual funds can be purchased without any trading commissions. However, they might come with operational expenses like sales loads or early redemption fees.  

Tax efficiency  

ETFs generate fewer capital gains since they have a lower turnover and use the in-kind redemption process for the cost basis of their holdings. But in mutual funds, you are still eligible to receive capital gains from the generated sale of assets within the fund. The same is true even if you experience loss in your investment.  

ETFs vs. mutual funds: Advantages and disadvantages 

Let’s now look at each investment type’s upsides and downsides. First, let’s go with ETFs: 

Pros and cons of ETFs 

ETFs offer several benefits for investors. They provide diversification by giving access to a wide range of sectors and assets. Since many ETFs are passively managed, they often have lower fees. 

Some also reinvest dividends automatically, though this depends on the type of ETF. This kind of investment usually trades close to their net asset value. Plus, they trigger fewer capital gains. 

As for its downsides, some ETFs might not cover smaller companies, which limits diversification. Dividend-focused ETFs might offer lower yields than individual dividend-paying stocks. 

And while ETFs are low-cost compared to mutual funds, they can still be expensive when compared to holding individual stocks, especially with frequent trading. 

Pros and cons of mutual funds 

Mutual funds pool money from many investors to create a large fund managed by professionals. They offer strong potential returns, often averaging 10 to 12 percent annually. Some funds tied to the S&P 500 can perform even better. 

Mutual funds are easy to access through Registered Retirement Savings Plans (RRSPs), employer-sponsored plans, or personal investment accounts. They also offer low expense ratios, built-in diversification, and automatic dividend reinvestment. Fund managers handle all the buying and selling for you. 

But like all types of investment, there are some drawbacks. Some mutual funds charge high fees, including sales loads or commissions, which can cut into your returns. You also have less control over taxes. 

If the fund manager sells assets, it can trigger taxable distributions, even if you didn’t sell anything. These might be taxed as capital gains or regular income, depending on how long the fund holds the assets. 

Why invest in ETFs? 

ETFs have become a popular choice among investors looking for flexibility and control. They are often favoured by those who want to manage their own portfolios while keeping costs low. Here are some reasons why ETFs continue to grow in popularity: 

• ETF prices move throughout the trading day, which makes them attractive to both active traders and buy-and-hold investors. 

• Another benefit is trading flexibility, since investors can buy or sell ETF shares at market prices during exchange hours. 

• ETFs also tend to have lower fees, particularly those that follow a passive index strategy. 

• ETFs are known for their transparency, as most providers publish a full list of holdings online every day. 

• Unlike many mutual funds, ETFs usually have no minimum investment requirement. 

Why invest in mutual funds?  

There are a lot of investors who find that mutual funds align with their financial goals. One reason is that mutual funds are well-suited for long-term investing. This encourages people to stay invested even when markets are unstable. 

Investors also benefit from having their assets managed by professionals. The option to automate contributions adds convenience and reduces stress. Other reasons why savvy investors choose mutual funds include: 

• Mutual funds have low entry points. As such, it’s easy to start investing in smaller amounts. 

• Mutual funds offer built-in diversification, which helps reduce the risk of losses from any one company. 

• Mutual funds are available in registered accounts like RRSPs and Tax-Free Savings Accounts (TFSAs). 

• Mutual funds do not require constant monitoring. This makes it attractive to hands-off investors. 

Check out this table that summarizes what we’ve discussed so far about ETFs vs. mutual funds: 

Are ETFs better than mutual funds in Canada? 

ETFs and mutual funds both offer access to diversified portfolios. Still, they suit different strategies. ETFs are better for investors who want lower fees, more control over trades, as well as tax efficiency. They trade like stocks and often follow an index. 

On the other hand, mutual funds are managed by professionals and might work better for hands-off investors or those using retirement accounts where daily trading isn’t a priority. 

Choosing between the two depends on your objectives and how involved you want to be in managing your investments. If you want lower fees and the flexibility to buy or sell during market hours, ETFs might be for you. But if you value convenience and professional oversight, mutual funds might make more sense. 

No matter which one you pick, the best choice is the one that fits your strategy—not someone else’s. And whatever investment tool you choose, be patient when waiting for your portfolio to grow through profits, returns, or capital gains. 

Want to read similar articles about ETFs, mutual funds, and other types of investments in Canada? Feel free to check out our investments page.