Comparing ETFs, Index Funds, and Mutual Funds in Canada

Regardless of your investment, it is vital to determine the range of available options. Whether it be mutual funds in Canada, an index fund, or an Exchange-Traded Fund (ETF), this in-depth comparison will take the guesswork out of developing a stable long-term investment plan. You've likely heard of ETFs, index funds, and mutual funds in Canada. These financial instruments can provide long-term gain, usually with minimal risk. But, the only way to know which is the best investment decision for you is by fully understanding their functional operational differences.

What is a Mutual Fund?

A mutual fund is a collection of investments in securities, bonds, stocks, and other assets that provide returns. Professional money managers manage the fund's pool assets from the shareholders. These managers allocate the funds to a predetermined set of investments to produce capital gain or income for the investors. One of the biggest differentiators between mutual funds, ETFs, and index funds is that mutual funds own the securities within their portfolio. Therefore, they can only trade once daily, after the markets close. While the markets are open, professional money managers will buy securities for the fund. Mutual funds in Canada typically have multiple asset classes and instruments, providing investors with great diversity.

Benefits of Mutual Funds

Mutual funds are managed through more advanced and complex strategies than ETFs and index funds. Mutual funds in Canada aim to outperform the market. Investors can also have great potential returns by reinvesting dividends into the fund. In addition, mutual funds are a convenient way for people to invest in various carefully chosen securities, reducing volatility through diversification.

Drawbacks to Mutual Funds

Unfortunately, there are some significant downsides to mutual funds. For example, mutual funds have some of the highest marketing and management fees compared to ETFs and index funds. They are costly compared to other funds. Since professional money managers actively manage them, they are much less predictable than other funds. The average management fee, also known as the expense ratio, for equity mutual funds in Canada is 2.23%. That means for every $100 you invest in a mutual fund, you will likely pay $2.23 in fees. That doesn't sound like much until you get into larger portfolios. If you had $400,000 invested into a mutual fund, you would likely pay upwards of $9,000 in fees! Imagine how much could have been reinvested into the market to earn you even more money!

Type of Investor Mutual Funds Benefit

Even though it can be expensive, mutual funds have often outperformed many popular ETFs and index funds.

Even though it can be expensive, mutual funds have often outperformed many popular ETFs and index funds. Long-term investors looking for actively managed portfolios may benefit from a fund with historically high returns. It is a very convenient way to invest in a large pool of securities, and the fund's shares are usually very reasonably priced. All investors must research the past performance, management, load fees, and expense ratios of any mutual fund they are interested in.

How to Invest in a Mutual Fund in Canada

Once you determine your investing goals and research the types of mutual funds you are interested in, investing in the fund is straightforward. Many people choose to invest in mutual funds through a retirement account. Others may choose to invest in mutual funds through an education savings account. If you have other investing goals besides retirement and education, you can also purchase shares of mutual funds through a brokerage account. It is important to note that many mutual funds have minimum investments. These funds work best with investing on a regular schedule with a strategic exit strategy in the future.

What is an Exchange-Traded Fund (ETF)?

An exchange-traded fund (ETF) is a collection of investments such as stocks, bonds, and other securities. They operate similarly to mutual funds because they usually track a specific sector, index, or commodity type. However, they can be bought and sold on the exchange throughout the day like individual stocks (hence, exchange-traded funds). This means you won't have to wait until the market closes to trade an ETF. Some ETFs have securities within a targeted industry, while others are single-industry focused. Unlike mutual funds, ETFs do not involve any actual ownership of securities.

Benefits of Exchange-Traded Funds

You can invest in a passively managed ETF or an actively managed ETF.

The primary benefit of ETFs is that you can invest in a vast collection of investments with one purchase, and you don't have to choose each asset. They are also considerably cheaper to buy than mutual funds since the expense ratio is markedly lower. You can invest in a passively managed ETF or an actively managed ETF. Passively managed ETFs attempt to replicate the performance of a broader financial market index, while portfolio managers direct actively managed ETFs. Unfortunately, actively managed ETFs can be much more expensive than passively managed ETFs.

Drawbacks to Exchange-Traded Funds

Unlike a mutual fund, ETFs cannot be redeemed for cash since the securities within an ETF are not owned by the fund. This arrangement makes investments in an ETF less liquid than mutual funds. Actively managed ETFs typically have much higher fees than index funds. Single industry funds have comparatively low diversification since the securities are not spread throughout various sectors.

Type of Investor ETFs Benefit

ETFs can be a great investment choice for investors who seek low minimum, tax-efficient investments with low fees. In addition, unlike mutual funds, the trade execution is straightforward since ETFs can be traded multiple times throughout the day.

How to Invest in an ETF

If you're looking to invest in an ETF, the best thing to do is research which funds you are interested in, depending on the length of time you plan on investing, the purpose, and your overall financial goals. Then, once you develop a strategy, you can choose between online and traditional brokers. When deciding which broker to choose, consider the volume of trades they handle, their expense ratio, commissions, holdings, and past performance.

What is an Index Fund?

An Index fund is a portfolio of stocks or bonds that aims to replicate the performance of a particular market index. These funds can only be traded at the end of the day and offer lower expenses and fees than other actively managed funds (such as mutual funds or active ETFs). Index funds operate under the theory that the market as a whole will outperform a single stock over the long term due to diversification. As a result, financial experts, such as American business magnate Warren Buffett, highly recommend them.

Benefits of Index Funds

Index funds are great because they allow investors to buy various stocks and bonds with a single purchase. Instead of buying 100 different stocks individually, you can find an index fund that contains stocks from the industries you're interested in and buy into the index fund directly. Investing in an index fund gives you access to the power of a wide variety of stocks and bonds. In addition, many retirement accounts include index fund holdings.

Drawbacks to Index Funds

Because the pool of stocks and bonds matches the market index, index funds have a passive management style. This market matching is the biggest reason the fees are significantly less than other funds. In addition, unlike active mutual funds, the specific list of securities an index fund invests in does not change.

Type of Investor Index Funds Benefit

Index funds are an excellent investment for those seeking to minimize fees while buying into a wide variety of stocks and bonds that seek to mimic the performance of a financial market index.

How to Invest in an Index Fund

The first step to investing in an index fund is to pick the market index you want to track. Once you've determined which index suits your investing goals and personal interests, you can choose one of the funds that track that index. Then, you can easily buy index fund shares by opening a brokerage account online or in person through a company offering the fund you seek.

Which is Right for You?

What's your next step? Are you going to invest in mutual funds, exchange-traded or index funds? Depending on your investing goals and strategies, one of them will likely be more beneficial to your specific needs than the others. Don't get too hung up on the specifics, though. The best choice is the one that you are comfortable investing in! Here at Creditpicks, we're all about investing in YOU! Sign up for our newsletter today for financial inspiration delivered to your inbox every month. Your future self will thank you!