MUTUAL FUNDS, INDEX FUNDS & ETFs

What are the similarities, the differences and why are they important?

Simon Brady, CFP® Founder, Anglia Advisors

Anglia Advisors provides educational workshops and presentations for attendees desiring general advice on investments and personal finance. Topics may include issues related to financial planning, educational and estate planning, retirement strategies, or various other economic and investment topics.  Workshops are educational in nature and do not involve the sale of insurance or investment products. Information presented will not be based on any one person’s need nor do we provide individualized investment advice to attendees during our general sessions.

INDEX FUNDS ARE TYPES OF MUTUAL FUNDS & ETFs

Mutual Funds Exchange Traded Funds (ETFs)

Index Funds

ACTIVELY MANAGED FUNDS ARE TYPES OF MUTUAL FUNDS & ETFs

Mutual Funds Exchange Traded Funds (ETFs)

Actively Managed Funds

MAIN SIMILARITIES BETWEEN MUTUAL FUNDS AND ETFs

- Both are “buckets” of securities, providing diversification benefits

- Both are regulated by the Investment Company Act of 1940

- Both must distribute dividends - Both are valued by the aggregate contents of

the “bucket” - Both carry annual fees to own (“expense

ratios”)

MAIN DIFFERENCES BETWEEN MUTUAL FUNDS AND ETFs

- Determination of the contents of the “bucket”

- How you buy and sell - Annual fees - Turnover (cost/tax efficiency)

DETERMINATION OF THE CONTENTS OF THE BUCKET

- MUTUAL FUNDS: Usually determined by a human fund manager.

- ETFs: Usually determined by the composition of an existing index or occasionally an algorithm.

HOW YOU BUY AND SELL- MUTUAL FUNDS: One price, once a day. Usually no transaction fee to buy/sell & no spread to pay, but sometimes a minimum initial purchase size.

- ETFs: Trade all day on exchanges like stocks, usually a transaction fee and a spread. Never a minimum purchase size.

ANNUAL FEES

- MUTUAL FUNDS: Usually need to cover the costs of human management, analysts, brick and mortar offices, trading technology, trading costs, marketing & distribution fees, cash drag.

- ETFs: Hardly any of these costs will apply.

ANNUAL FEES

AVERAGE MUTUAL FUND ANNUAL FEE: 1.3% per year ($130 per $10,000)

AVERAGE ETF ANNUAL FEE: 0.35% per year ($35 per $10,000)

TURNOVER (COST/TAX EFFICIENCY)

Turnover is a measure of how much buying and selling is going on within the fund.

Example: if a fund has an annual turnover of 50%, then half the holdings it owns on

January 1st will have been sold and replaced by others by December 31st of that year.

TURNOVER (COST/TAX EFFICIENCY)

High turnover can generate two types of costs, both of which are passed on to the owners of the funds:

• Transaction fees • Capital gains taxes

AVERAGE MUTUAL FUND TURNOVER:

130%

AVERAGE ETF TURNOVER:

Virtually zero

TURNOVER (COST/TAX EFFICIENCY)

SUMMARY

- Not all ETFs are index funds, but most are. - Not all mutual funds are actively managed,

but most are. - Both are buckets of securities whose price

is determined according to performance of the aggregate contents of the bucket.

- Consequently, both provide compelling diversification advantages over the practice of picking and owning individual stocks.

SUMMARY- Usually mutual fund holdings are selected and

traded by human fund managers. - ETF holdings are usually determined by the

makeup of an index and are not adjusted unless the components of the index change (rare).

- ETFs can sometimes generate transaction costs to buy/sell and carry spreads, mutual funds do not generate these costs.

- On average, mutual funds carry much higher annual fees (“expense ratios”) than ETFs.

- On average, mutual funds have much higher turnover than ETFs, generating more fees.