Quora Answer: Which is Better: an Exchange-Traded Fund or a Mutual Fund?

The following is my answer to a Quora question: “Which is Better: an Exchange-Traded Fund or a Mutual Fund?” 

On the surface, they are similar since both types of funds consist of a mix of different assets, making them cost effective means of diversifying a portfolio.  The biggest difference is that exchange-traded funds can be traded intra-day, like stocks.  Mutual funds can only be purchased at the end of the trading day, at a price calculated from the net asset value. 

There is no “better”.  Both mutual funds and ETFs have a place in a portfolio, and address different needs.  For one, mutual funds tend to have a higher minimum investment requirement.  This makes ETFs more accessible to smaller retail investors since an entry position costs far less.  Part of the reason why mutual funds have that higher minimum investment requirement is because they have higher management fees because many mutual funds are actively-managed.  The fund needs to beat the market for the fund manager to earn bonuses.  ETFs tend to be passively managed.  Additionally, mutual fund transactions are directly between investors and the fund.  The price of the fund is not determined until the end of the business day when NAV is calculated. 

ETFs are created or redeemed in large lots by institutional investors.  These shares trade throughout the day between investors, like stock.  It does not need to go through the fund manager.  This means, like a stock, ETFs can be sold short.  As such, ETFs are favoured more by traders and speculators, while mutual funds are for long-term investors.  But because ETFs prices change throughout the day, trading can take place at a value other than the NAV, allowing arbitrage. 

In summary, if you actively trade, and engage in price speculation, then ETFs suit you better.  If you are an investor with a longer investment horizon, then mutual funds are where you want to put your money.