Mutual Funds vs. Index Funds vs. ETFs
What’s the Difference?
Investing can feel like a complicated world, but it doesn't have to be! Let's break down three popular options—mutual funds, index funds, and ETFs—in simple terms so you can make smarter choices with your money.
Mutual Funds
Think of mutual funds like a big pot of money that lots of people contribute to. A professional manager then uses that money to invest in a variety of stocks, bonds, or other assets.
When you invest in a mutual fund, you get a share of that pot of money. If the value of the pot grows, the value of the share that you bought also grows!
Mutual funds are good for people who want a pro to handle their investments, don’t want to be involved in managing their money, and who don’t mind losing a chunk of their retirement savings to high fees charged by these companies.
Index Funds
Now, let's talk about index funds. These are like the set-it-and-forget-it option of investing. Instead of relying on a team of experts to handpick investments, index funds aim to replicate the performance of a specific market index. There are many market indexes, and they’re essentially just groups of stocks and/or bonds that have something in common.
For example, there’s an index that contains all of the biggest technology companies in Canada, and one that includes all of the clean energy companies in Canada. There’s also a popular index that you might’ve heard of that contains the largest 500 companies in the US (called the S&P 500). An index fund aims to match the performance of the index it’s following. So an index fund for the S&P 500 index will try to match the growth of the companies that are in the S&P 500 index.
Professionals who work for the companies that own the index funds are responsible for making adjustments to the fund to make sure the companies that it’s investing in are up to par. They don’t review the mix of stocks in an index fund as often as a mutual fund, so the fees are much lower than mutual funds. Index funds offer a simple solution to cut down on fees compared to mutual funds, while keeping your risk low. You buy them directly from the company that sells them.
ETFs (Exchange-Traded Funds)
Last but not least, we have ETFs, or exchange-traded funds. Think of these as the cool, tech-savvy cousins of mutual funds and index funds. Like index funds, ETFs aim to replicate the performance of a specific index, but they trade on exchanges like stocks. Think of a stock exchange similar to Amazon, where you can easily buy ETFs and stocks anytime, all through a single platform (for example, Wealthsimple). This means you can buy and sell them more easily than mutual funds (which are typically purchased through a financial advisor) and index funds (which are usually purchased directly from the company). Plus, ETFs often come with lower fees compared to mutual funds, making them a cost-effective choice for many investors. ETFs tend to be more popular than index funds in Canada, and there has been a shift over recent years in the US, with more people buying ETFs than index funds as well.
Key Differences
Management Style: Mutual funds are actively managed by professionals who select investments based on research and analysis. Index funds and ETFs, on the other hand, passively track the performance of a specific index without active management.
Trading Flexibility: ETFs trade on exchanges like stocks, allowing investors to buy and sell them throughout the day. Mutual funds and index funds, meanwhile, are bought and sold at the end of the day.
Costs: Mutual funds often come with higher fees and expenses compared to index funds and ETFs, which can eat into your returns over time. Index funds and ETFs typically have lower fees compared to mutual funds, making them a cost-effective option for many investors.
Final Thoughts:
In a nutshell, mutual funds, index funds, and ETFs each offer unique benefits and considerations for investors. Whether you prefer the hands-off approach of mutual funds, the simplicity of index funds, or the flexibility of ETFs, there's an option out there to suit your investment style and goals. So, take your time, do your research, and find the option that's right for you. Happy investing!
About The Authors
Amanda and Siobhan found a shared passion for personal finance shortly after completing their MBAs in 2018. Amanda excelled as a Director of Product in the tech industry, while Siobhan established herself as a leader in e-commerce before transitioning to academia as a Professor.
In 2020, they joined forces to found Hiver Academy, a platform born from their own experiences and triumphs in conquering student loans and building wealth. Realizing that financial success is within reach once the complexities are simplified, their mission now revolves around empowering individuals to achieve financial freedom.
With a wealth of knowledge and a commitment to demystifying money and investing, Amanda and Siobhan are dedicated to helping others navigate the path to success.
