At the heart of the ETFs vs mutual funds discussion is the fact that ETFs have much lower fees

You might say we specialize in “plain vanilla” stocks, bonds, ETFs—the ordinary kind, in other words, without lots of added features and fees. But even so, investors looking to put their money into investment products need to understand the ETFs vs mutual funds pros and cons.

There are similarities between ETFs and mutual funds, and ETFs are actually a little like conventional mutual funds, but with two key differences.

1. ETFs trade on a stock exchange. First, ETFs trade on a stock exchange throughout the day, much like ordinary stocks. So you can buy them through a broker whenever the stock market is open, and generally you pay the same commission rate that you pay to buy stocks. In contrast, you can only buy most conventional mutual funds at the end of the day. Commissions can vary widely, depending on negotiation with your broker or fund dealer.
2. The MER (Management Expense Ratio) is generally much lower on ETFs than on conventional mutual funds. That’s because most ETFs take a much simpler approach to investment. Instead of actively managing their clients’ investments, they generally try to invest so as to mirror the holdings and performance of a particular stock-market index.

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ETFs vs mutual funds, pros and cons: What else you need to know about ETFs

ETFs are unlike other investment innovations; they aim to simplify your investing, rather than complicate it.

As mentioned, traditional ETFs are set up to mirror the performance of a stock-market index or sub-index. They hold a more-or-less fixed selection of securities that represent the holdings that go into the calculation of the index or sub-index.

Investors can buy ETFs on margin or sell them short. These funds have gained popularity among investors, mainly because many ETFs offer very low management fees.

What to watch out for with ETFs

• International ETFs can have more risk
• Some new ETFs can be more expensive—and risker—than traditional ETFs
• ETFs can be volatile, depending on the stocks they hold.

ETFs vs mutual funds, pros and cons: What you need to know about mutual funds

Mutual funds are diversified portfolios of equities and investments in which small investors can take part. They are an investment product, with individual shares being called units.

One interesting note about buying mutual funds comes from the Dalbar organization.

This U.S. research firm’s studies of top-performing mutual funds show most of their investors who jump in at the top will lose money or make negligible returns. That’s because most investors in a top performing fund only buy into the fund after it has already made big gains. Investors also tend to sell former top-performing funds only after a major slump in the value of their holdings. When you chase investment performance, it’s all too easy to buy at the top and sell at the bottom.

Types of mutual funds to stay away from:

• Beware of buying vaguely described mutual funds
• Avoid buying mutual funds that trade in derivatives
• Avoid mutual fund managers who trade heavily
• Avoid buying mutual funds with a lot of dead weight
• Avoid buying mutual funds with anonymous managers
• Get out of buying the riskiest “theme” mutual funds

ETFs vs mutual funds, pros and cons: We think ETFs are generally the better investment

Here are three main reasons why we prefer ETFs over buying mutual funds:

• ETFs are less expensive to hold. ETFs give you a low-cost way to invest in a narrow market segment. That’s typically cheaper than investing in a mutual fund with a similar focus. With fees as low as 0.10% a year for ETFs vs. mutual funds that can charge you 2% to 3% or higher on their fund. ETFs can save you a lot of money and boost your returns over time.
• ETFs trade on stock exchanges, just like stocks. That’s different from mutual funds, which you can only buy at the end of the day at a price that reflects the fund’s value at the close of trading.
• ETFs have low turnover. Shares are only added or removed when the underlying index changes. As a result of this low turnover, you won’t incur the regular capital gains taxescapital gains taxes generated by the yearly distributions most conventional mutual funds pay out to unitholders.

Do you prefer actively managed mutual funds or passively managed ETFs?

This article was originally published in 2017 and is regularly updated.