Comparing Index ETFs and Mutual Funds

We understand that investing in index exchange trade funds (ETF) can be a good option for beginning investors, but what if you’re also looking at mutual funds, and you want to compare purchase costs between the two?

MyMoneyBlog says to look at the index ETFs Historical Bid/Ask Spread Values and the mutual fund’s NAV (Premium or Discounts to Net Asset Value).

Since ETFs are by definition traded on an open exchange, there can be differences between what people are currently willing to pay (the “bid” price), and what people are willing to sell at (the “ask” price). Even if you assume the ETF is priced correctly at it’s inherent value, this bid/ask spread means you will be overpaying a bit when you buy, and losing a bit when you sell…

…NAV is simply the value of the shares of the mutual fund minus any liabilities like expense ratio. A mutual fund always trades once a day, exactly at its NAV.

We’ll admit we don’t really know much about this particular subject, but we’ve bookmarked it for when we’re older. The post also has links to different sites that reveal different fund’s historical data. — BEN POPKEN

Tools For Evaluating Index ETF vs. Mutual Fund Purchases [My Money Blog]
(Photo: Getty Images)

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  1. Andamom says:

    The difference is generally passively (ETF) vs. actively managed (MF). If you believe that a particular fund manager can beat its benchmark, than you may want to opt for a mutual fund. Of course, the real question is whether that manager can beat the benchmark though after loads (front and back-end) and additional fees. (Note: Seeing as how there is some interest in this topic, I’ll post about this subject in the near future on my site…Thanks for the heads up.)

  2. skittlbrau says:

    @Andamom:

    Not entirely true – I work for an asset manager, so I can speak (somewhat) intelligently on the subject.

    There are both actively and passively managed ETFs on the market, just as there are actively and passively managed Mutual Funds. Whether an investor believes actively or passively managed is more appropriate investment is entirely up to the investor.

    To trade in ETFs you will be paying a fee to your broker for executing the transaction. This fee could be a per unit fee or a flat trading fee per transaction. On top of that, ETFs have liabilities, reflected in the expense ratio. The primary benefit of an ETF is liquidity. Since shares cross the tape at many times of the day, the price will change and you can track intraday prices as you can with a stock. If you don’t like what an ETF is doing, you can trade at the 10 am price, the noon price, or the 2 pm price, all which can be different.

    Mutual funds are traded once a day at NAV, which is the assets of the fund minus liabilities (expense ratio). There will only be one given price per day, so if the market is tanking and you want to get out, you can’t until the end of the day at the earliest. Some mutual funds have loads (fees to purchase) and 12B-1 fees (shareholder servicing), and some do not. All the fees must be laid out in the mutual fund’s prospectus.

  3. skittlbrau says:

    And to piggyback on today’s earlier discussions of dollar cost averaging, if you only have $100 to invest at a time, mutual funds are generally a better choice than ETFs.

    Since you pay a trading commission on each trade, ETFs make more sense if there is a lump-sum that you want to invest, since it spreads the commission over a larger number of shares.

  4. urban_ninjya says:

    ETFs are good for one time buys, while traditional mutual funds are better for long term investing. Here’s why:

    ETFs usually have a slightly lower expense ratio their their mutual fund counter parts. They can easily be traded like any stock and do not incur any loads or misc expense fees. The weakness of ETFs are you have to pay a transaction charge like any other stock and you can’t easily buy fractional shares. This makes them idea for one time investments and trading.

    Traditional mutual funds allow fractional shares. Great when you want to reinvest the dividend distributions, and when you want to do regular montly automatic investments.

  5. Notsewfast says:

    What baa says is absolutley true.

    Another thing to note is that index ETFs dont’ neccesarily track the indexes perfectly. This is because of the derivatives that they hold. As a result, they may not respond in the same way to market shocks in the same way that the indexes will.

    Index ETFs are a good way to gain some passive exposure to equity markets with good liquidity, but an investor should be aware of the discrepancies.

  6. purkinje says:

    It’s worth noting that you can, in fact, purchase fractional shares of ETFs through companies like Sharebuilder. I own a little over 4.5 shares of VDE that way.

  7. Hoss says:

    Should the subject of the article have any interest to a small investor? My cursey review sees spread statistics for some of the smaller EFTs — even if the small investor was interested in those ETFs, a $1,000 investment has a spread cost of 50 cents. Do I have this right??

  8. skittlbrau says:

    @Hossofcourse:

    Yes, you are right that the spread cost is about 50 cents.

    Really, the spread isn’t what gets the average investor. ETFs are a tradeoff between trading commissions and the (generally) lower expense ratios of ETFs, as compared to mutual funds.

  9. leejames says:

    Other people are mentioning this, but the real trick is to always minimize your fees/loads/expense ratios, no matter what you’re investing in.

    Losing several ticks a year to fees or expenses can really wreck your plans even if your investments are doing well, or twist the knife if they’re tanking.

  10. sunwukong says:

    @lee-reamsnyder: This is especially true up here in Canada were the MERs are much higher on managed funds than ETFs.

  11. urban_ninjya says:

    @purkinje:
    Buying fractional shares through sharebuilder is not the same as true DRIP investing. With a say a account with the mutual fund, the dividends are revinvested directly. The benefits are mutual fund NAVs drop during this period, and you’re buying the shares at a lower price point.

  12. UnStatusTheQuo says:

    My broker has realized the high fees associated with mutual funds and due to those, allows for 2 free mutual fund trades per month to make it more bearable for those that like mutual funds. For ETFs, my broker charges the lower of: 1) a flat $9.95 fee, or 2) $0.05 per share, with a $4.95 minimum.

    It’s not something I take advantage of as I like trading options on ETFs.

  13. numeroprime says:

    There is another factor to consider: With Mutual Funds, several owners can liquidate their shares,generating expenses for the fund. These expenses are shared by EVERYONE.

    During one of the last market escapes, My SP500 Index charged me a few hundred dollars (I believe through share reduction) to cover expenses caused by others. I dont understand why the people that generate the expenses dont pay for them, but it seems to be that way for mutual funds.

    Additional enlightenment appreciated, thanks!