As long term savvy investors, we have a number of investment tools that we tend to focus on, primarily mutual funds and Exchange Traded Funds (ETFs). One of the things that I did not understand initially was the difference between mutual funds and ETFs. When do I use them and how do I decide which is the appropriate tool?
First we need to understand the differences between the two and then how that impacts how we invest. The high level difference between the two comes down to two things:
- ETFs trade like stocks (variable price throughout the day)
- Mutual funds are purchased at the end of each trading day (based on a calculated price)
- ETFs are passively managed
- Mutual funds are generally actively managed
This is of course a sweeping generalization, but you get the idea.
The other factor in considering ETF vs Mutual Fund is cost. Because ETFs are passively managed, they tend to be much lower cost than actively managed funds. This makes for better long term gains. However there is now a grey area, since the advent of the low cost index funds, that are generally passively managed.
So where and under what circumstances do I use ETFs vs mutual funds?
While the wisdom of the FIRE community is to hold your accounts with Vanguard, my employer-provided 401k is in Fidelity, so for the sake of convenience I have all of my accounts there. I don’t have much to be honest, I keep it simple: the 401k, traditional and Roth IRAs, and a brokerage account.
I only use low cost indexed mutual funds for my 401k, as ETFs are not available, but for my Roth IRA and individual investment account, I can choose mutual funds or ETFs. I used to have both accounts in ETFs, but a Fidelity have recently introduced some very low cost index funds so I don’t even bother with ETFs at this time.
- FZROX – Fidelity total market mutual fund. Expense ratio 0.00%
- ITOT – S&P total market ETF. Expense ratio 0.03%
You can’t really get much lower that zero cost. If that ever changes, then I will consider moving back to ETFs again.