Investing in funds or ETFs: what’s the difference?

Investing in funds or ETFs, easy peasy. Right? Often these types of investments are mentioned in the same breath, but there is indeed a difference between funds and ETFs. In this article, we’ll explain it to you. This information is intended to give you insight into the world of ETFs (Exchange Traded Funds) and mutual funds. Please note that this is not investment advice. Investing involves risk, so inform yourself well before you make any decisions.

This article was written by Nadia Bellussi, wealth manager, investment expert and affiliate of Elfin!

What are ETFs?

ETFs, or exchange traded funds, are a type of basket containing stocks or bonds. You can buy them on the exchange, through a broker, just like individual stocks. This makes it possible to buy and sell shares in an ETF during stock market trading hours, offering flexibility to the investor. So with investing in an ETF, with one purchase, you can expose your money to many types of companies. So diversification is a breeze.

Beware, investing has risks! You may lose (part of) your deposit. Invest only with money you can spare. Promise!

The operation of ETFs

An ETF tracks the performance of a particular index or specific sector. If you invest in an AEX ETF, you follow the AEX, the Dutch index with the 25 largest companies. So with 1 purchase, of the AEX ETF, you invest in 25 companies at the same time. An ETF is managed by a fund manager who ensures that the ETF follows the index as closely as possible. This offers you as an investor the opportunity to diversify without having to choose individual shares.

Examples of ETFs

• S&P 500 ETF: This ETF tracks the S&P 500 index, consisting of 500 major U.S. companies.
• Technology ETF: Invests in major technology companies such as Apple, Microsoft, and Amazon.

Benefits of ETFs

• Diversification: With one ETF share, you can easily diversify your investments.
• Liquidity: ETFs are tradable on the exchange during the day.
• Lower costs: The management costs of ETFs tend to be lower than those of traditional mutual funds.

Risks of ETFs

• Market risk: Like individual stocks, ETFs are subject to market movements.
• Tracking error: A small deviation between the performance of the ETF and the tracked index.
• Liquidity risk: Less trading in some ETFs can lead to higher price differences when buying and selling.

When to use ETFs?

• Starting investors: Choose an ETF for good diversification.
• Long-term investors: Good for investors who want to benefit from market growth over longer periods of time.
• For diversification: Ideal for including different asset classes (slang for “type of investments”) in your portfolio.

Types of ETFs

1. Equity ETFs: Invest in stocks of specific themes or regions.
2. Bond ETFs: Consist of different types of bonds.
3. Sector ETFs: Focus on a specific sector.
4. Commodity ETFs: Offer exposure to commodities through physical stock or futures contracts.
5. Currency ETFs: Investing in currencies.
6. Hedge fund ETFs: Simulate hedge fund strategies.
7. Thematic ETFs: Focused on specific trends such as renewable energy or cybersecurity.

Where can you invest in ETFs?

You can invest in an ETF through a broker, which is an intermediary between you and the actual investment product. Think of a broker such as DEGIRO, BUX, Saxo or Easybroker.

Investment funds explained

Investment funds are pools of money from multiple investors to invest in various types of products, such as stocks and bonds, managed by professional fund managers. They offer a way to invest without having to analyze the market yourself. Each fund has a specific objective and investment strategy, which is outlined in the fund prospectus.

How do mutual funds work?

When you invest in a mutual fund, you buy shares or units of the fund, and those shares give you an ownership interest in the products that are in the fund. The value of these shares depends on the fund’s net asset value (NAV), which is calculated daily by dividing the total value of assets in the fund by the number of shares outstanding. Funds gather the expertise of fund managers who are responsible for making investment decisions to manage the fund according to its objectives. Profits and losses are distributed, minus any expenses.

You can invest in passive and active funds. Active mutual funds are managed by professional fund managers who actively research the market and make decisions about which assets to buy or sell with the goal of outperforming the benchmark and generating significant returns. This is in contrast to passive funds, such as index funds, which simply follow a market index.

Actively managed funds are often more expensive; you incur more costs because there are people actively managing the fund. To justify the cost, active funds must outperform the market. That’s not always the case…

Types of mutual funds

• Equity funds: Invest in stocks of various companies.
• Bond funds: Invest in bonds and often a mix of different bonds. Read more about bonds here.
• Index funds: passively track a particular index. Sometimes a fund includes a mix of indexes, or ETFs.

Advantages of mutual funds

• Potentially Higher Return: The ability to beat the market, especially in volatile or inefficient markets.
• Flexibility: Ability to respond quickly to changing market conditions.
• Risk management: Active management can help better manage risk by, for example, exiting risky sectors when necessary.

Mutual fund risks

• Higher costs: Active management involves higher costs, including management fees and performance fees.
• Risk of underperformance: There is no guarantee that the fund will beat its benchmark; some actively managed funds underperform the market for long periods of time.
• Dependence on fund management: The expertise and decision-making of the fund manager play a crucial role, which can be risky if these decisions prove unprofitable.

When to choose active mutual funds?

Active funds are particularly attractive to investors seeking higher returns and willing to pay higher fees for the potential of outperforming the market. They are also suitable for those who value professional risk management and want the expertise of a fund manager to seize opportunities in the market.

Investing in funds or ETFs: what’s the difference?

Investing in funds or ETFs: what’s the difference, is obvious. ETFs are traded like stocks and track an index, resulting in lower costs. Actively managed mutual funds, on the other hand, are managed by fund managers trying to beat the market, sometimes resulting in higher costs. An ETF is often a copy of an index, can be traded by yourself any time of day (if the stock market is open) and helps you make diversified investments at low cost. Funds are a completely different type of investment, but the idea is the same: diversification. Bringing together money from multiple investors and investing the pool of money in a mix of all kinds of investments.

Start investing (provided you do so with money you can spare for a long time, the disclaimer!), small or large, and learn to understand the market. ETFs and mutual funds both have their pros and cons, so choose what best suits your strategy and goals. Diversification is the key to a balanced investment portfolio.