ETFs or Mutual Funds - Fidelity (2024)

Neither mutual funds nor ETFs are perfect. Both can offer comprehensive exposure at minimal costs, and can be good tools for investors.

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ETFs or Mutual Funds - Fidelity (1)

Exchange-traded funds (ETFs) and mutual funds are simply structures or vehicles that facilitate access to underlying investments. Enthusiasts refer to ETFs as modernized mutual funds—even calling them mutual funds 2.0. Meanwhile, detractors cite the shortfalls of ETFs and tout mutual funds as king. Cutting through the confusion is really just a matter of understanding the differences, and understanding where each structure makes the most sense.

Let's review the fundamental differences between the 2 structures.

The basics

On one level, both mutual funds and ETFs do the same thing.

Let's imagine, for instance, 2 products that are designed to track the S&P 500: an ETF and a mutual fund. If you look under the hood, both products will hold all (or most) of the 500 stocks in the index, in the exact proportion in which they exist in the index. At this point, the 2 product structures are identical.

The difference of course is that ETFs are "exchange traded." That means you can buy and sell them intraday, like any other stock. By contrast, you can only buy or sell index funds only once per day, after the close of trading. You do this by contacting the mutual fund company directly and telling them you want to acquire or redeem shares.

What does all that mean for investors? Let's take a closer look at ETFs.

ETFs or Mutual Funds - Fidelity (2)

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The positives of ETFs

  • Intraday liquidity: Those fancy words mean you can buy and sell ETFs at any time during the trading day. If the market is falling apart, you can get out at 10 a.m. In a mutual fund, you would have to wait until after the close of trading … which could be a costly delay.
  • Lower costs: Although it's not guaranteed, ETFs often have lower total expense ratios than competing mutual funds, for a simple reason: when you buy shares of a mutual fund directly from the mutual fund company, that company must handle a great deal of paperwork—recording who you are and where you live—and sending you documents. When you buy shares of an ETF, you do so through your brokerage account, and all the recordkeeping is done (and paid for) by your brokerage firm. Less paperwork equals lower costs. Most of the time.
  • Transparency: ETF holdings are generally disclosed on a regular and frequent basis, so investors know what they are investing in and where their money is parked. Mutual funds, by contrast, are required to disclose their holdings only quarterly, with a 30-day lag.
  • Tax efficiency: ETFs are almost always more tax efficient than mutual funds because of how they interact. For more details, see ETFs vs. mutual funds: Tax efficiency.
  • Greater flexibility: Because ETFs are traded like stocks, you can do things with them you can't do with mutual funds, including writing options against them, shorting them, and buying them on margin.

The cons of ETFs

  • Commissions: Over the last few years the majority of trading platforms offer commission-free ETF trading programs, including Fidelity, but always check before you trade.
  • Spreads: In addition to commissions, investors also pay the "spread" when buying or selling ETFs. The spread is the difference between the price you pay to acquire a security and the price at which you can sell it. The larger the spread—and for some ETFs, the spread can be quite large—the larger the cost. There is no way to get around this.
  • Premiums and discounts: When you buy or sell a mutual fund at the end of the day, you always transact exactly at its stated "net asset value" (NAV), so you always get a "fair" price. While mechanisms exist that keep ETF share prices in line with their fair value, those mechanisms are not perfect. At any given moment, an ETF might trade at a premium or at a discount to its NAV. If you buy at a premium and sell at a discount, ouch … you've lost out.
  • General illiquidity: While exchange trading sounds great, not all ETFs are as tradable as you might think. Some trade rarely, or only at wide spreads. These become the financial equivalent of the Hotel California: You can never leave.

Conclusion

Neither mutual funds nor ETFs are perfect. Both can offer comprehensive exposure at minimal costs, and can be good tools for investors.

The choice comes down to what you value most. If you prefer the flexibility of trading intraday and favor lower expense ratios in most instances, go with ETFs. If you worry about the impact of commissions and spreads, go with mutual funds. If taxes are your priority, reserve the ultra-tax-efficient ETFs for taxable accounts and use mutual funds in tax-deferred accounts.

It's important to note that this isn't an either/or decision. Mutual funds and ETFs can live perfectly happily side by side in a portfolio .

ETFs or Mutual Funds - Fidelity (2024)

FAQs

What is the downside of ETFs? ›

For instance, some ETFs may come with fees, others might stray from the value of the underlying asset, ETFs are not always optimized for taxes, and of course — like any investment — ETFs also come with risk.

Is it better to invest in mutual funds or ETFs? ›

ETFs and index mutual funds tend to be generally more tax efficient than actively managed funds. And, in general, ETFs tend to be more tax efficient than index mutual funds. You want niche exposure. Specific ETFs focused on particular industries or commodities can give you exposure to market niches.

Does Fidelity charge fees for ETFs? ›

$0.00 commission applies to online U.S. equity trades, exchange-traded funds (ETFs) and options (+ $ 0.65 per contract fee) in a Fidelity retail account only for Fidelity Brokerage Services LLC retail clients. Sell orders are subject to an activity assessment fee (from $0.01 to $0.03 per $1,000 of principal).

Are Fidelity ETFs worth it? ›

ETFs have several advantages for investors considering this vehicle. The 4 most prominent advantages are trading flexibility, portfolio diversification and risk management, lower costs versus like mutual funds, and potential tax benefits.

Why choose an ETF over a mutual fund? ›

ETFs offer numerous advantages including diversification, liquidity, and lower expenses compared to many mutual funds. They can also help minimize capital gains taxes. But these benefits can be offset by some downsides that include potentially lower returns with higher intraday volatility.

Why should I not invest in ETFs? ›

Market risk

The single biggest risk in ETFs is market risk. Like a mutual fund or a closed-end fund, ETFs are only an investment vehicle—a wrapper for their underlying investment. So if you buy an S&P 500 ETF and the S&P 500 goes down 50%, nothing about how cheap, tax efficient, or transparent an ETF is will help you.

Should I switch from mutual funds to ETFs? ›

If you're paying fees for a fund with a high expense ratio or paying too much in taxes each year because of undesired capital gains distributions, switching to ETFs is likely the right choice. If your current investment is in an indexed mutual fund, you can usually find an ETF that accomplishes the same thing.

Which is safer, ETF or mutual fund? ›

Both are less risky than investing in individual stocks & bonds. ETFs and mutual funds both come with built-in diversification. One fund could include tens, hundreds, or even thousands of individual stocks or bonds in a single fund. So if 1 stock or bond is doing poorly, there's a chance that another is doing well.

Why are ETFs more risky than mutual funds? ›

The short answer is that it depends on the specific ETF or mutual fund in question. In general, ETFs can be more risky than mutual funds because they are traded on stock exchanges.

Should I use Vanguard or Fidelity? ›

While Fidelity wins out overall, Vanguard is the best option for retirement savers. Its platform offers tools and education focused specifically on retirement planning.

What is the downside to Fidelity? ›

In most situations, you will find what you need at Fidelity. There are a few downsides. Fidelity does not offer cryptocurrency investing. The company is also missing some features found on other investment platforms, like futures trading and paper trading, where you can practice trading.

What is the downside of ETF vs mutual fund? ›

ETFs are generally lower than those that are charged by actively managed mutual funds because their managers are merely mimicking the contents of an index rather than making regular buy and sell decisions, For some investors, the design of a passive ETF is a negative.

Should I just put my money in ETF? ›

If you're looking for an easy solution to investing, ETFs can be an excellent choice. ETFs typically offer a diversified allocation to whatever you're investing in (stocks, bonds or both). You want to beat most investors, even the pros, with little effort.

Is it possible to lose money on ETF? ›

An ETF with a low risk rating can still lose money. ETFs do not provide any guarantees of future performance. As with any investment, you might not get back the money you invested.

Are there any risks with ETFs? ›

Their investors also benefit from very low fees. Still, there are unique risks to some ETFs, including a lack of diversification and tax exposure. Many of these risks can be minimized or avoided by choosing wisely among the many ETFs available.

Are ETFs riskier than funds? ›

Both are less risky than investing in individual stocks & bonds. ETFs and mutual funds both come with built-in diversification. One fund could include tens, hundreds, or even thousands of individual stocks or bonds in a single fund. So if 1 stock or bond is doing poorly, there's a chance that another is doing well.

Are ETFs good for beginners? ›

The low investment threshold for most ETFs makes it easy for a beginner to implement a basic asset allocation strategy that matches their investment time horizon and risk tolerance. For example, young investors might be 100% invested in equity ETFs when they are in their 20s.

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