Traditionally, mutual funds were the main way people would invest in funds. But ETFs have gotten more and more popular over the years. We start by explaining their commonalities and their differences. It will then become clear to you why we think ETFs are better when managing your own portfolio of funds. Yet, we end with a way you can have the best of both worlds.
What's a mutual fund?
A mutual fund is like a big basket where many people put their money. This basket is then used to buy a mix of investments, like stocks and bonds. The idea is to spread out the risk and give people a chance to earn money from these investments without having to pick and manage them individually. Think of it as pooling money together with others to invest in a variety of things, hoping to make more money over time.
Most mutual funds are actively managed, meaning that fund managers make decisions to try to outperform the market. You buy mutual funds at your bank or with a professional asset manager.
What's an ETF?
An ETF is also a fund, like a mutual fund. But the key difference is that it's traded on a stock exchange. The name "ETF" stands for exchange-traded fund. So rather than buying it directly from the bank, you buy it on an exchange from another investor. A broker allows you to access the stock exchanges.
Another difference is that ETFs tend to be passively managed, rather than actively managed like a mutual fund. Instead of having a fund manager that tries to get a better return than the market, an ETF simply tracks an index. That's why ETFs are sometimes also called trackers. An index is a basket of stocks or other investments that are representative of a particular market. For instance, in Belgium we have the BEL 20 which represents the Belgian stock market. A more widely known index is the S&P 500, which tracks the 500 largest American companies.
It turns out that a passive approach based on indexes usually leads to better returns in the long term. So it's likely that investing in a passive ETF will grow your wealth more than investing in a fund with your bank. Let's dive deeper into the differences.
The differences between a mutual fund and an ETF
Let's have a look at main differences:
Passive investing beats active investing
The active management style used by mutual funds, where a fund manager tries to be "smarter" than the market, usually doesn't work. For instance, the ESMA, the European regulator for the financial markets, found out that 75% of active funds perform worse than their benchmark index. The main reason is costs. Active funds are expensive, as the fund managers, analysts and other specialists need to be paid. Yet all this work doesn't translate to higher returns.
In their book De hangmatbelegger, that Curvo co-founder Yoran wrote with Tim Nijsmans, they look at the historical performance of the main Belgian mutual funds over the last 5 years, and compared to an ETF. Although 5 years is not long enough to draw conclusions, it is further anecdotal evidence that confirms that passive investing leads to better returns than active investing.
The superior returns of passive investing is the reason why Curvo's philosophy is rooted in passive investing. We think index investing is the best way for most people to grow their wealth for the long-term.
Finally, let's consider the mutual active fund KBC Equity Fund World (ISIN BE6213775529). It is offered by the large Belgian bank KBC and uses the MSCI ACWI index as its benchmark. But when we compare the fund's past performance to an ETF that tracks the MSCI ACWI, we see it has largely underperformed.
Mutual funds are much more expensive
Fund providers charge a fee for managing their funds. A fund's total expenses are indicated by its total expense ratio, or TER. The TER is expressed as a percentage of the total assets. For example, if an ETF manages 100 million euros and the costs are one million euros, the TER is 1%.
ETFs are 10 to 20 times cheaper than the active funds at your bank. You can find ETFs as cheap as 0.05% in annual cost, while banks sometimes dare to charge more than 2% on an annual basis for funds. As we mentioned before, you pay lower fees because index funds are very cheap to run. Tracking an index is simple. You buy the stocks in the index and update when it changes. It doesn't need expensive analysts or other specialists.
The underperformance of the KBC Equity Fund World fund compared to an MSCI ACWI ETF can partially be explained by the difference in cost. Whereas the active mutual fund by KBC has a TER Of 1.72%, the ETF costs 0.45%. And for many funds, the difference is even higher.
The funds in the Curvo portfolios were chosen as to minimise ongoing fees. The average cost of each portfolio ranges from 0.17% for the Protective portfolio to 0.27% for the Growth portfolio.
On top of the ongoing costs, mutual funds often also have entry fees, and sometimes even exit fees.
Buying through your bank or a broker
You buy mutual funds from your bank or an asset manager. But since ETFs are traded on stock exchanges, they can only be bought through a broker. In that respect, mutual funds have an advantage because brokers charge a fee every time you buy or sell an ETF.
🇧🇪 Do you live in Belgium? Then check out our guide for the best brokers.
Easy fractional investing with mutual funds
ETFs are traded in units, just like stocks. With most brokers, you can't buy fractions of ETFs. Say you want to invest €100 and the ETF trades at €57.78 per share. Buying units means that you can only buy one share and you'll be left with €42.22 in cash. Mutual funds don't have this problem. You'll be able to invest the whole €100.
ETFs can be traded all day long, but it doesn't matter for long-term investing
ETFs trade like stocks on an exchange, with prices fluctuating throughout the day based on supply and demand. This means you can buy or sell ETFs at market price at any time during the trading day. On the other hand, mutual funds are priced once at the end of the trading day based on their net asset value. You buy or sell mutual fund shares directly at this price.
However, this doesn't matter when you're adopting a passive buy-and-hold strategy for the long term. Frequent trading leads to worse investment results in almost all cases, because each trade comes at the cost of a broker fee and taxes.
Mutual funds and ETFs are regulated the same way
It is important to note that ETFs have the same legal status as classic investment funds, namely Undertakings for Collective Investment in Transferable Securities (or UCITS). They are also supervised by the same supervisory bodies: the FSMA in Belgium (Financial Services and Markets Authority) and the AFM in the Netherlands (Financial Markets Authority). So in that respect, ETFs are no less safe than investment funds.
As with traditional investment funds, ETFs also have to place their underlying investments with a depository institution. If an ETF issuer goes bankrupt, your investments are not gone. Another ETF issuer will then take over management of the fund. In fact, this is quite easy, since it is just tracking an index.
Should you invest in mutual funds or ETFs?
If you choose to manage your own portfolio of funds, ETFs that track an index have our preference. The passive approach, combined with lower fees, means that your savings will compound to much greater amounts than with the active funds sold by your bank. The high fees charged by mutual funds are good for the bank, but bad for your financial future.
The best of both worlds at Curvo
The portfolios available through Curvo consist of index funds. They're the best of both worlds. They follow an index like an ETF, because we think index investing is the best way for most people to grow their wealth for the long-term. Yet they also allow fractional investing. And because they don't have broker fees, Curvo is ideal for monthly investing.
Furthermore, when you sign up, we start by asking you some questions to get to know your goals and your tolerance for risk. At the end, the best portfolio for you is built. There's no need to figure out which combination of ETFs is best for you out of the thousands of ETFs available.
Learn how Curvo works.
Summary
I hope it has become clear to you that the passive approach followed by ETFs leads to better investment returns for you, than investing in a mutual fund at your bank. If you want to manage your own investment portfolio through a broker, ETFs are the way to go. But if you're looking for an easier approach, Curvo may be an option.