Mutual Funds vs ETFs: Identical Twins or Sibling Rivalry?

You received your first paycheck and decided to invest in your company’s 401(k).

Congrats!

You see the offerings and decide to buy a Vanguard stock index fund, VTSAX.

But you notice it’s also avialble as an ETF, known as VTI.

What the hell?

What’s the difference? Why should you care? And ultimately, what’s best for your portfolio?

The Mutually Exclusive Option

Mutual funds were invented way back in the 1920s, so they’ve seen some play time. Originally created to group together several different securities, mutual funds are similar to ETFs: you buy one security, and get exposure to many.

The difference? Mutual funds don’t trade on an exchange. They settle once a day, at the end of the day, when their NAV (Net Asset Value) price is determined. Once all the securities in the fund have stopped trading for the day, the NAV of the fund is calculated and it’s at that specific price to which investors either buy or sell the fund.

An investor can enter a buy or sell order during the morning, and that order will be fulfilled at the end of the day.

Not so with ETFs - which are like the mutual fund’s cool younger brother.

ETFs: Exchange Traded Funds

ETFs came about in the early 1990s as a way to gain exposure to a basket of securities, like mutual funds, but in a trade-by-the-moment way.

ETFs trade intraday on an exchange, like the Nasdaq. This means they can trade every second of everyday, so there is constant price discovery. This also makes them a liquid way of buying and selling at any moment you wish.

They contain a group of individual securities which also, of course, trade intraday and go up and down at any particular moment. Because someone has to manage this ETF (similar to a mutual fund), someone is tasked with managing the different securities that make up the ETF and determine the proper securities to include, the weightings of each, etc.

So although you are buying 1 security (the ETF in question), you are actually gaining exposure to possibly thousands of individual securities. This makes them a popular choice among millions of everyday investors.

Example

Let’s compare a mutual fund with it’s twin ETF.

Vanguard offers VTSAX - Vanguard Total Stock Market Index Fund Admiral Shares mutual fund.

It has a NAV price, the performance change for the previous day, the minimum investment, and its expense ratio or cost to you.

$3,000 is not an easy initial investment hurdle for most. This is a barrier for the fund, but Vanguard sees it as protection - it prohibits traders from entering/exiting the fund in short periods which can cause disruptions in its management.

The expense ratio is 0.04%. For every $1,000 you invest, you pay $1,000 × 0.0004 = $0.40 annually. Not bad to get diversified exposure to tons of securities (3,861 to be exact).

VTI (Vanguard Total Stock Market ETF) has a market price of $220.02, which was last reported from yesterday’s market close (8/28/23). It also shows the NAV price ($219.95), which is the net asset value of all the securities it holds. You’ll notice the market price is slightly higher than the NAV - it traded at a premium.

The minimum investment is $1.00, so you’d only receive a fraction of 1 share. The expense ratio is 0.03%, so you’d only pay $0.30 for each $1,000 you invest. It may not seem like much, but if you invest $500,000, your cost difference between the mutual fund and ETF is $50 - for nearly identical securities.

So which to choose?

Of course, it depends. If you want to get in and out of the market during the trading day, then choose the ETF. (This could also seriously harm your overall returns.) If the intraday market swings are irrelevant to you, then choose the mutual fund.

Keep in mind the expense ratio costs, and what your ultimate goal is. Mutual fund managers also allow you to auto-contribute over a time period since they only trade at one time of day - the close. ETFs don’t allow this since they trade all over the place each moment.

Whatever you decide - make it long-term and be patient. Time is the most precious asset.

Save On,

Chris