5 Reasons Etfs Are Better Than Mutual Funds

For years, mutual funds were a classic pillar of traditional investing. They offered easy diversification and the expertise of a fund manager. But starting in 1993 a new type of security called an Exchange Traded Fund (ETF for short) arrived on the scene. We recently sent out an email explaining why we like ETFs better than mutual funds. Here are five reasons that ETFs get you more bang for your buck than a traditional mutual fund.

1. ETFs Have Lower fees

While both types of investment charge management fees, ETFs have much lower fees. It is not uncommon to see mutual funds that charge 2% or more for their services! That means that even if your mutual fund earns a steady 4% per year, after factoring in inflation and management fees, you are essentially taking home no profits! ETFs, on the other hand, usually charge below 1% in management fees, letting the money earned pad your pocket instead of theirs.

2. ETFs Can Have Better Trade Commissions

Another way that mutual funds can eat away at your returns is by paying commissions when you buy and sell shares of the fund. It is not uncommon to see a $9.95 commission per transaction when buying and selling mutual funds. ETFs sometimes offer commission-free trades. One of my favorite things about trading with a Questrade account is that you can trade ETFs for free! The ECN fees charged are often less than a cent per share and are miniscule compared to the commissions on mutual funds. In addition, having commission-free trades gives you a great opportunity to engage in dollar cost averaging.

3. ETFs Have Tax advantages

Part of successful investing is minimizing small fees that can eat away at your profits. Another one of these detractors is the capital gains tax. Mutual funds are known for blind-siding unknowing investors with taxes that eat their returns. This is because mutual funds are actively managed. Fund managers are constantly buying and selling shares in a mutual fund. Because of the way that an ETF is structured, there are fewer taxable transactions. The end result is that you end up paying fewer taxes on money earned through an ETF vs. than you would on money earned through a mutual fund. While tax can sometimes seem small and insignificant, over time it can make a big difference. This is also why we recommend investing with a TFSA, which allows you to grow your money tax-free.

4. ETFs Have Higher Liquidity

ETFs also have much more liquidity than mutual funds. While mutual funds are valued daily and traded daily, ETFs are traded on the open market. What this means is that anytime during market hours you can purchase an ETF just like you would a stock. This makes ETFs much easier to buy and sell than mutual funds. Because ET’s are traded between investors instead of between the investor and the fund, you avoid buying at a premium and selling at a discount. This is mostly important because it makes it easy to sell ETFs once you’ve reaped sufficient profits!

5. ETFs Have Better Performance

The final, and likely the most important difference between a mutual fund and an ETF is that ETFss typically earn more money. Without the complicated fee structure, ETFs earn their shareholders higher returns, and do better than most actively managed mutual funds. Over the past 5 years, 80% of Canadian mutual funds under-performed their S&P Composite.

You might be asking, how can professional investors fail so dramatically compared to the stock market? I mean, these are the best investors in the world. The problem is, their jobs are based on performance. Therefore, they’re trying to earn as much short term returns as possible. When you’re a long term investor like we are, you’re focused on getting results for longer than a year. The numbers don’t lie and in this case, simpler is better.

After taking a look at some of the differences between ETFs and their cousin mutual funds, we can see that ETFs are simply the better investment. Lower fees, commission-free trading, tax advantages, higher liquidity, and better performance make ETFs the hands down winner. It’s time for us to stop looking at ETFs as the new kid at school and instead welcome them into our portfolios. They are definitely here to stay, and offer a great chance for you to build a passive portfolio.

If you’re interested in building an ETF portfolio, check out our post on setting up an account with Questrade. As mentioned earlier, Questrade provides commission-free ETF purchases. If you’re already signed up with Questrade, check out the form below. We provide a free guide showing you how to fund your account and make your first trade!

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