If you're new to investing and have no idea where to begin, two of the most commonly recommended investment products are mutual funds and exchange-traded funds (ETFs). With both, you can create a diversified portfolio that could help you reach your short- and long-term financial goals.
Both mutual funds and ETFs deliver access to a well-diversified basket of securities from a wide variety of Canadian, U.S. and international stocks and bonds. With mutual funds and ETFs, investors can choose to invest broadly (ex. in an index fund that tracks the S&P/TSX Composite Index), or more narrowly (ex. dividend-paying stocks or a particular sector, like energy).
Mutual funds still dominate the investment market in Canada, with $1.9 trillion worth of assets.1 ETFs have become popular with investors with $355 billion in assets under management as of August 2023.2
Let’s explore how these two different types of investments work, and what the differences are before you start investing.
A mutual fund is a type of investment where money is pooled from various investors. A portfolio manager invests the money in a portfolio of securities, such as stocks and bonds. How they invest and manage the money depends on the objectives of the mutual fund. For example, you can purchase a mutual fund that's focused on growth, regular income or a combination of both.
ETFs are similar to mutual funds in the sense that they're a pooled investment vehicle featuring dozens or hundreds of individual securities depending on the index they track. An important difference between ETFs and mutual funds is that many ETFs are passively managed. While actively managed ETFs do exist, and are gaining popularity, this article will primarily focus on index-tracking ETFs.
For index-tracking ETFs, they track a particular index. For example, you could purchase an ETF that tracks the S&P/TSX Composite Index. That index tracks about 250 of Canada's largest public companies on the Toronto Stock Exchange.
Since there's no active security selection, you would pay a lower management expense ratio (MER) compared to mutual funds that are actively managed.
Another key difference between ETFs and mutual funds is pricing. ETFs are traded (bought and sold) on a stock exchange – similar to stocks – with the price fluctuating throughout the trading day. This is different from mutual funds which are priced once daily at the end of the trading day, after the market closes. So for a particular mutual fund, all daily transactions will occur at the same price, unlike an ETF, which will fluctuate in price throughout the day based on the value of the underlying securities in the index it tracks.
Traditionally, mutual funds use an active management approach. That's where fund managers actively watch market conditions and use their knowledge and experience to make investment decisions, including which securities to buy and when to sell them. The goal is to maximize returns for their investors while sticking to the investment objective of the mutual fund. This can be a highly appealing approach for investors since they're getting access to experienced professionals that can manage their investments.
With ETFs, a passive style of management is often taken. The goal is to simply track the performance of a recognized equity or bond index, such as the S&P 500 or FTSE Canada Universe Bond Index for Canadian bonds. When the underlying ETF is performing well, so would your ETF. If it were to drop in value, so would your ETF.
ETFs are a good fit for investors who have a good understanding of investing and have the time to dedicate to researching and trading funds.
It's worth mentioning that you can also purchase passively managed mutual funds. These are known as index funds, and they're also designed to track the performance of a market index.
Management fees will often be a strong consideration for investors when deciding between mutual funds and ETFs. Think of the management expense ratio (MER) as the fee to run the mutual fund and ETF. It pays for staff, operating expenses, taxes and more.
Generally speaking, actively managed mutual funds have an MER that ranges from 1.50% to 2.50%.3 Passive index mutual funds typically have an MER in the .75 to 1% range. For ETFs, the MER range is usually from 0.05% to 1.10% (for passively managed ETFs) or 0.75% to 2.50% (for actively managed ETFs).4
Fixed income funds/ETFs
Fixed income funds/ETFs are focused on products that offer regular income. Common holdings would be government/corporate bonds and treasury bills. While you can still lose money investing in bonds funds, there’s usually less risk and typically lower growth potential than equity funds.
Designed with long-term growth in mind, equity funds invest in stocks. While the value of your investment will fluctuate up and down, there's also a greater opportunity for growth. Equity funds can be further broken down as you can purchase ones that focus on growth, dividends, larger or blue chip companies or geography.
Balanced funds mix fixed-income and equities to reduce overall volatility. The asset mix of stocks and bonds of balanced fund can be found in its Fund Fact and simplified prospectus. Luckily, they are typically available to suit a range of different risk tolerances. Growth-tilted funds would have more equities while conservative funds would focus on fixed-income.
Sector or industry funds/ETFs
You can purchase mutual funds and ETFs that focus on a specific sector or theme, such as real estate, financial services and socially responsible investing. These types of funds can be appealing to people who are looking for more exposure to certain industries. For example, you could buy a real estate fund that gives you access to dozens of properties for less than the cost of a down payment on a single home.
Purchasing mutual funds and ETFs can be a straightforward process, but a little bit of knowledge may be required.
With mutual funds, they can be bought and sold any day the market is open. You can purchase mutual funds online, over the phone and in a branch. There are usually no additional trading fees involved for no load mutual funds (though if you buy through a broker there can be this type of fee).
When it comes to ETFs, you'll purchase them at market price throughout the day — just like stocks. To purchase them, you need an online brokerage trading account. Alternatively, you could have an investment advisor or broker assist you with your purchases. Since ETFs are traded like stocks, there may be a fee/commission charged when you buy and sell.
There's usually a low initial investment requirement, so both products can work for all types of investors.
Both mutual funds and ETFs are liquid investment products, so trading in and out of them is relatively easy. As in, you could easily access your money if you need it. There are no locked-in periods.
By investing a fixed-dollar amount on a regular basis, dollar-cost averaging helps control the effect of market volatility by smoothing out the average cost per unit of mutual funds purchased. For example, you may choose to have $100 taken off every paycheque to buy additional shares of a mutual fund. Unfortunately, dollar cost averaging with ETFs is impractical because there are trading costs associated with buying additional ETF shares, which can quickly add up.
Every fund company will have a report called a Fund Fact for their mutual funds and ETFs, where you'll find the following:
- Fund's name and code
- Investment objectives and strategy
- The fund manager (if applicable)
- Past performance
- Management fee
- Breakdown of holdings
In addition, mutual funds will disclose their top holdings monthly and all holdings semi-annually. Passively managed ETFs will typically disclose their holdings every day.
Did you know?5
The most frequently held investment products among Canadian investors
- 61% Mutual funds
- 49% Stocks
- 44% Guaranteed Investment Certificates (GICs)
- 21% Exchange-traded Funds (ETFs)
- 16% Bonds
|Actively Managed Mutual Funds
|Passively managed ETFs
|Actively managed by a professional money manager who has the flexibility to change the holdings (or composition) of the fund at any time
|Passively managed to closely track a recognized index, such as the S&P/TSX Composite Index. It does not have the same flexibility to change the holdings (or composition) of the index as an actively managed mutual fund
|How to buy
|Usually purchased through a financial institution (such as Scotiabank) or a financial advisor
|Purchased through a broker or online trading platforms (such as Scotia iTRADE)
|Traded and priced once daily, at market close
|Traded and priced throughout the day on exchanges (like stocks)
|Greater flexibility; free to deviate from the fund’s underlying index
|Must track the performance of index holdings (like the S&P/TSX Composite Index)
|Top holdings disclosed monthly; full holdings semi-annually
|Holdings disclosed daily
|Higher management fees
|Lower management fees
|Better suited for Dollar-Cost Averaging
|Not suited for Dollar-Cost Averaging
It's not fair to say one investment product is better than the other. Mutual funds and ETFs both provide diversification but are different products. If you're struggling to decide between the two, consider the following:
- Do you want active or passive management for your investments?
- What level of fees work for your financial plan?
- How comfortable are you with investing?
- What is your investment strategy?
New investors typically gravitate towards mutual funds since an investment manager will manage their portfolios for them. You can work with them on your investment.
On the other hand, ETFs are attractive to individual investors that who become familiar with investing and are looking for low-cost products for their portfolios.
Regardless of what you go with, you need to choose a fund that lines up with your investment goals. Knowing how different investment products work and what they're invested in is part of your journey.
To learn more about mutual funds visit the “Learning Centre” on scotiafunds.com for helpful videos and information.