ETFs vs. Index Mutual Funds: Which Wins Out?

ETFs vs. Index Mutual Funds: Which Wins Out?

They both have their share of pros and cons. Find out which investment is smarter for you and your retirement.

     When considering ways to diversify your retirement portfolio while still investing safely, both exchange-traded funds (ETFs) and index mutual funds are good options. But to know which one is right for you, keep in mind the following differences.

     ETFs trade on stock exchanges, whereas mutual funds invest in anything from stocks and bonds to real estate. Index mutual funds invest in an entire stock index (for example, every stock in the S&P 500) and pool money from multiple customers together. Many ETFs track an index as well, but some focus on smaller portions of the market.

     Since ETFs operate like individual stocks, they can be bought or sold at any point throughout the business day. Investors in mutual funds don’t have the same luxury; they can only purchase or sell at the end of the day. There is also no minimum investment for most ETFs.

     Compared to mutual funds, ETFs incur lower operating fees because they have fewer brokerage expenses—mutual funds generally charge within 1 to 3% while ETFS remain in the 0.1 to 1% range. It’s important to still consider brokerage fees when purchasing an ETF, though, especially if you’re investing smaller sums of money.

     A monthly operating cost of $12, for example, means that even if you deposited $120 monthly, you’d be losing 10% of your investment (maybe more, maybe less depending on whether your ETF’s price rises or falls). Brokers often require customers to pay a commission when they sell their ETFs, too.

     In this scenario, choosing a standard index mutual fund is a better idea because the fees over time would actually be lower. But if, say, you were to deposit $120,000 at once in an ETF, the $12 fee suddenly seems pretty negligible. For larger deposits, go with ETFs; for smaller, gradual investments, stick with mutual funds.

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