Understanding the differences between mutual funds and ETFs is important. Both can be quite useful but operate differently in terms of how they are traded. Mutual funds are what most of us have in our work retirement accounts. They are a collection of individual stocks organized into a mutual fund following two primary methods. Actively managed and passively managed. Actively managed funds are created and maintained by a team of investment professionals following the objective(s) of the mutual fund. Because these types of funds have people working on them the costs are higher.
Passively managed funds follow an index and their investments and % of allocations mirror whatever index they are following. Since there is less human interaction the expense ratios tend to be significantly lower.
Mutual funds settle daily, meaning at the end of each trading day all buy/sell orders are processed regardless of what time of day you placed the order. Another key feature of mutual funds is the ability to buy partial shares. This makes mutual funds the ideal choice for automatic investing, you determine the amount and then an order is made for that amount regardless of the price per share at the end of the day. Its an easy way to accumulate funds in a Roth IRA or work retirement account. On the whole there are fewer ESG type mutual funds that will appeal to impact investors.
Mutual Funds are great for:
- Automatic investing – can buy partial shares
- Simplification of portfolio and management
- Not subject to intra-day volatility
- Access to actively managed funds run by experienced professionals
Exchange traded funds (ETFs) are similar to mutual funds, except they trade like stocks and can be bought and sold throughout the day. Generally speaking ETFs have lower expense ratios than mutual funds. There is another sub group of funds that are relevant to our interests in impact investing. These funds mirror and index but then exclude certain companies that don’t fit a desired criteria. A good example is SPYX, SPDR’s S&P 500 fund that excludes holdings in fossil fuel reserves.
Exchange Traded Funds (ETFs) are great for:
- Highly flexible, can trade throughout the day
- Tremendous diversity and niche investing
- Many socially conscious ESG ETFs to choose from
- Low minimum investment amount, allows you to start investing quicker
Hopefully this post was useful in identifying some of the key benefits of each type of investment. In future posts I will look at specific options that appeal to me as an impact investor. I own both mutual funds and ETFs in my investments. Determining which is better for you is an individual choice based on the level of engagement you want to have with your investments.