ETFs VS MUTUAL FUNDS – I PREFER ETFs; HOW ABOUT YOU?
Disclaimer: Good Day, Readers. WealthBuildingPowers blog is a financial literacy/competency blog and does not provide specific investment recommendations.
Click below to listen to the podcast or keep reading today’s blog
TODAY, I PREFER ETFs; HOW ABOUT YOU?
I purchased my first mutual fund, outside a 401K plan, shortly after graduating college. Wendell Williams, one of my favorite bosses, recommended I study Peter Lynch and the Magellan Mutual Fund. Under Lynch’s management, between 1977 and 1990, the fund averaged over a 29% annual return, making Magellan the best-performing mutual fund in the world.
When the market had a 29.6% correction in my 20s, I probably had no more than $5,000.00 in this fund. Imagine my fear when, in one day, I lost $1,500.00! How many months did it take me to save that $1,500.00? Being a newbie investor, I PANICED and sold and had no idea when to reenter the market, so I missed the early recovery returns. After three months down, the fund went on to gain 845% over 12+ years.
A couple of lessons. Most of us cannot accurately time the market. If you made a good investment decision based on facts, weather the storm. To a young investor just getting started, it felt like a Tsunami. In reality, this was a short blip. I NEVER SHOULD HAVE SOLD
Mutual Funds vs. ETFs:
Mutual funds and ETFs offer diversification and professional management, but they differ in ways that can impact cost, convenience, and overall returns.
Today, I own the S&P 500 ETF
What Are ETFs?
An exchange-traded fund (ETF) is similar to a mutual fund but trades on stock exchanges like an individual stock. Most ETFs are passively managed and track an index or a specific sector. ETFs offer intraday trading flexibility, and their prices fluctuate throughout the trading day based on supply and demand.
Pros of ETFs
- Lower Expense Ratios: Most ETFs, mainly passive ETFs, have lower expense ratios than mutual funds. This makes them cost-effective and especially appealing to long-term investors who want to maximize returns while minimizing fees. I invest in the Vanguard S&P 500 ETF, VOO. The VOO ETF has annual operating expenses of 0.03%. So you pay $30 for $100,000.00 invested in this fund. Compared to paying one to two percent for a mutual fund or $1,000.00 to $2,000.00 for every $100,000.00 invested. {Below, I demonstrate the impact of a portfolio’s value investing in low-cost ETFs versus mutual funds. See- Impact of Fees.}
- Trading Flexibility: ETFs trade like stocks on an exchange, so they can be bought and sold throughout the trading day. This flexibility allows investors to respond to market changes instantly, saving them money when a mutual fund’s price surges the next day.
- Tax Efficiency: ETFs tend to be more tax-efficient than mutual funds. This is primarily due to the redemption process, which minimizes capital gains distributions and can lead to tax savings.
- No Minimum Investment: Investors can buy as little as one share of an ETF, making it an accessible option for investors who may not have the minimum amount needed to buy into a mutual fund.
Cons of ETFs
- Trading Commissions: Although many brokerages now offer commission-free trading on ETFs, some still charge fees.
- Potential for Overtrading: The ability to trade ETFs throughout the day might tempt some investors, particularly beginners, to trade too frequently. Frequent trading can result in transaction fees and potential losses, primarily if driven by short-term market fluctuations.
- Dividends Are Not Automatically Reinvested: ETF dividends are usually not automatically reinvested, unlike mutual funds. Investors must manually reinvest or use a brokerage’s dividend reinvestment plan.
- Market Price Fluctuations: ETFs are traded on an open exchange, meaning their prices can fluctuate throughout the day. This may not be a drawback for long-term investors, but it can lead to higher volatility and emotional responses for those new to investing.
What Are Mutual Funds?
A mutual fund is a pool of money collected from thousands of investors to invest in stocks, bonds, or other assets. Mutual funds are managed by professional (and well-paid) fund managers, trying to achieve returns that meet specific investment objectives, such as growth, income, or a combination of both. Mutual funds come in two main varieties: actively managed and passively managed. Actively managed funds rely on fund managers who aim to beat the market, while passively managed funds—typically index funds—track the performance of a particular index, like the S&P 500.
Pros of Mutual Funds
- Professional Management: Mutual funds provide professional management for investors who don’t have the time or inclination to monitor and rebalance a portfolio, which is theoretically beneficial in actively managed funds.
- Automatic Reinvestment: Mutual funds allow dividends and capital gains to be automatically reinvested, which can compound wealth over time.
- Less Day-to-Day Volatility: Since mutual funds are priced only once daily, they are less influenced by daily market volatility.
- Diverse Offerings: With options in equity, bond, balanced, and sector-specific mutual funds, investors can find funds that align with various financial goals and risk tolerances.
Cons of Mutual Funds
- Higher Fees: Actively managed mutual funds typically have higher management fees, which eat into returns. The average expense ratio of mutual funds tends to be significantly higher than that of ETFs, especially for actively managed funds.
- Minimum Investment Requirements: Many mutual funds have minimum investment requirements, often starting at $1,000 or more. While some funds may offer lower minimums, ETFs generally have no minimums aside from the cost of a single share.
- Less Flexibility in Trading: Since mutual funds are only priced once daily at the end of the trading day, they lack the flexibility that ETFs offer. Investors cannot buy or sell mutual funds mid-day, limiting their ability to capitalize on market movements.
- Potential for Capital Gains Tax: Even if an investor doesn’t sell their mutual fund shares, they may still be subject to capital gains taxes due to the fund’s internal trading activity. This can be disadvantageous for tax efficiency, especially for non-tax-advantaged accounts.
The Impact of Fees- Why I Stopped Investing in Mutual Funds
To illustrate the cost difference of investing $100,000 while adding $6,000 per year over 40 years with different annual fees (0.03%, 1%, and 2%), I summarize the outcomes based on the below assumptions:
- Initial Investment: $100,000.00
- Annual Contribution: $6,000.00
- Investment Duration: 40 years
- Average Annual Return: 7% before fees
Summary Chart
| Fee Rate | Future Value (40 years) |
| 0.03% ETF | $1,098,275.57 |
| 1% – Mutual Fund | $853,610.56 |
| 2% – Mutual Fund | $674,114.53 |
The cost difference between the scenarios:
- Between 0.03% and 1% fee: Difference = $1,098,275.57 – $853,610.56 = $244,665.01
- Between 1% and 2% fee: Difference = $853,610.56 – $674,114.53 = $179,496.03
- Between 0.03% and 2% fee: Difference = $1,098,275.57 – $674,114.53 = $424,161.04 Missed Profits
This chart and the calculations demonstrate the costly impact of seemingly modest fees. FEES MATTER!
Choosing What Works for You
Whether you opt for mutual funds, ETFs, or a combination of both depends on your investment goals, risk tolerance, and preferences. ETFs are typically better for new investors and those seeking low-cost, tax-efficient, and flexible investments. However, mutual funds may benefit those who prefer hands-on management, specific investment goals, or strategies that could benefit from active management.
It’s your decision. Sometimes, we may want a specific mutual fund and believe the gains make up the fees. Regardless of which you select, understand the fund’s strategy, fees, the fund manager’s tenure and experience, the fund and the fund manager’s historical returns, and the benchmark index on which the fund compares its performance. While mutual funds and ETFs offer benefits, they have become increasingly popular among individual investors due to their lower costs, trading flexibility, and tax efficiency. For those with long-term investment goals, such as retirement savings or building wealth, ETFs—especially passive index ETFs—are often more cost-effective.
Whether you choose ETFs or mutual funds, making regular contributions and maintaining a diversified portfolio are the keys to growing your wealth steadily over time.
The paths to financial freedom are UNLIMITED. CHOOSE YOUR OWN!
LET’S MAKE SOME MONEY – CRYPTOCURRENCY, ANYONE?
WHAT SUBJECTS DO YOU WANT TO READ NEXT? WHAT QUESTIONS CAN I ANSWER? UNTIL NEXT TIME!
YOUR GREATNESS IS NOT WHAT YOU HAVE; IT’S WHAT YOU GIVE! – SOME CHARITIES I SUPPORT
St Jude Hospital: The mission of St. Jude Children’s Research Hospital is to advance cures and means of prevention for pediatric catastrophic diseases through research and treatment. Consistent with the vision of our founder Danny Thomas, no child is denied treatment based on race, religion, or a family’s ability to pay.https://www.stjude.org/
Wounded Warrior Project: An American charity and veterans service organization that offers a variety of programs, services and events for wounded veterans of the military https://wilsoncountynokillanimalshelter.mywcn.com/
Folds of Honor: Providing life-changing scholarships to the spouses and children of America’s fallen or disabled military. And now, our mission expands to the families of America’s first responders. On our watch, those who protect our freedoms and our families will know they are not forgotten. https://foldsofhonor.org
Wilson’s No-Kill Animal Shelter: A N0-Kill shelter that is a top-rated non-profit. They compassionately care for all their animals. https://wcnkas.org
Tunnel To Towers: Since 9/11, we have been helping America’s heroes by providing mortgage-free homes to Gold Star and fallen first responder families with young children and by building specially adapted smart homes for catastrophically injured veterans and first responders. We are also committed to eradicating veteran homelessness and helping America to Never Forget September 11, 2001. https://dogood.t2t.org/give/320847/#!/donation/checkout
The Oracle of Omaha’s Investment Strategy Explained
Bill Gates Says This Is the Most Important Thing He’s Learned from Warren Buffett. (Hint: It Has Nothing to Do with Money) Two billionaires are linked by one common denominator.
WARREN BUFFETT’S NET WORTH IS DRIVEN BY THESE IRONCLAD TEN RULES
Warren Buffett Says This 1 Simple Habit Separates Successful People From Everyone Else http://flip.it/_AzPx9
WARREN BUFFETT UTILIZED COMPOUND INTEREST TO BECOME THE 3RD RICHEST MAN ON THE PLANET!
WARREN BUFFETT UTILIZED COMPOUND INTEREST TO BECOME THE 3RD RICHEST MAN ON THE PLANET!
WANT TO LEARN HOW TO BECOME WEALTHY – READ “THE MILLIONAIRE NEXT DOOR”
THE ONE BOOK YOU SHOULD READ…….
COMPOUND INTEREST IS THE EASIEST WAY TO DOUBLE OR TRIPLE YOUR MONEY
COMPOUND INTEREST IS THE EASIEST WAY TO DOUBLE OR TRIPLE YOUR MONEY
INVESTING IN STOCKS IS COLOR BLIND – WHAT IS STOPPING YOU?
INVESTING IN STOCKS IS COLOR BLIND – WHAT IS STOPPING YOU?
FINANCIAL LITERACY IS JUST NOT THAT COMPLICATED – TRUST ME!
https://wealthbuildingpowers.com/2019/04/01/financial-literacy-is-just-not-that-complicated-trust-me/
To Join Wealth Building Powers BLOG:
PLEASE SIGN UP TO FOLLOW ME BY PROVIDING YOUR E-MAIL IN THE WORDPRESS BLOG PAGE SUBSCRIBE BOX!
Thank you to my followers and readers for your likes and comments. All comments, recommendations, and feedback are welcomed and utilized to improve this blog.
ABOUT ME
I am a proud nerd (as my beautiful wife and daughter have told me) investment and finance blogger with an NC. State, Chemical Engineering, University Rutgers, MBA and Harvard University, Advanced Management education.
I left a corporate career because I desired to make a difference as a speaker and writer. I was blessed to be coached and mentored by strong women and men in my family and professional life. It is my time to serve and give back.
DISCLAIMER
I started my first business at ~13 years of age (a small but brilliantly created plant nursery). I am a successful investor in stocks, options, and real estate and am happy to share my finance and investment lessons. I am NOT a licensed financial advisor. Please do not construe my suggestions on this blog as recommendations for your situation. As an investor, you must establish your risk/loss tolerance. Investment in any asset involves risk, including complete loss.
Please seek your licensed CPA or fiduciary financial advisors for individual financial advice.
I write this weekly blog to make an impact by reaching an audience and demonstrating the need for financial literacy. I will help you get there.
