The difference between Stocks, ETFs, Index Funds, and Mutual Funds and which is best
This article explains the difference between stocks, ETFs, Index Funds, and Mutual Funds along with which is best depending on your financial goals.
TL;DR – Stocks are great for building wealth whereas ETFs, Index Funds, and Mutual Funds are good for protecting wealth.
Before we jump into the differences, there are a few terms we wish to define:
- Asset Class: A group of investments such as (stocks), fixed income (bonds), real estate, cryptocurrency, etc.
- Expense Ratio: The annual fee the investor pays to own the asset class. The expense ratio covers expenses such as administrative labor, advertising, and other expenses.
- Intraday Trading: The ability to buy and sell equities during trading hours. Trading hours vary per country. In the US, trading hours are 9:30am to 4pm (EST). In the UK, trading hours are 8am to 4:30pm (GMT +1). In India, the trading hours are 9:15am to 3:30pm (GMT +5:30).
Here are the differences between Stocks, ETFs, Index Funds, and Mutual Funds.
Stocks
A stock is a publicly traded company that is bought and sold primarily through stock exchanges. The expense ratio of a stock is 0%. You can buy and sell stocks and you will not be charged a fee for holding that stock. For example, if you bought a share of AAPL, you will not be charged a fee for holding AAPL. Keep in mind, that your broker may charge a commission to buy and sell a stock.
Expense Ratio: 0%
Intraday Trading: Yes
ETFs (Exchange Traded Funds)
An ETF is a bundle of stocks and bonds. In some cases 100 stocks and in other cases more than 1,000 stocks. The expense ratio of an ETF is around .1% which is less expensive than mutual funds. This means the fund itself will charge you around .1% per year for just owning the ETF. For example, if you own $10,000 shares of fictional ETF ABC, this fund will charge you $10/year to own it. An advantage of an ETF is when you buy an ETF at any time during the day, you will receive the ETF immediately at the price shown. You don’t have to wait until the end of the day like an index fund or mutual fund. Keep in mind, that your broker may charge a commission fee to buy and sell an ETF. The commission fee is a separate fee from the expense ratio.
Expense Ratio: Approximately .1%
Intraday Trading: Yes
Index Funds
An Index Fund may also contain over 1,000 stocks. The expense ratio of an Index Fund is around .1%. This means the fund itself will charge you around .1% per year for just owning the index. For example, if you own $10,000 shares of index fund ABC, this fund will charge you $10/year to own it. When you buy an index fund at any time during the day, you don’t receive the index until the end of the day. This means you don’t receive the index at the price shown, you receive the index at the closing price. Keep in mind, that your broker may charge a commission fee to buy and sell an index fund. The commission fee is a separate fee from the expense ratio.
Expense Ratio: Approximately .1%
Intraday Trading: No
Mutual Funds
A Mutual Fund may also contain over 1,000 stocks. The expense ratio of a Mutual Fund is between .5% and 2.5%. These funds can be expensive because they are more actively managed than ETFs and Index Funds. If you own $10,000 shares of fictional Mutual Fund ABC at an expense ratio of 1.5%, this fund will charge you $150/year to own it. Similar to an index fund, when you buy a mutual fund at any time during the day, you don’t receive the mutual fund until the end of the day. This means you don’t receive the mutual fund at the price shown, you receive the mutual fund at the closing price. Keep in mind, that your broker may charge a commission fee to buy and sell a mutual fund. The commission fee is a separate fee from the expense ratio.
Expense Ratio: Approximately .5 – 2.5%
Intraday Trading: No
Which is best?
Stocks
If you’re in a position where you want to build wealth faster, you should consider allocating your money toward individual stocks. There is no better way to build wealth than stocks. Keep in mind, that investing in stocks is not a get-rich-quick scheme. If you’re patient, you will see big results due to the power of compound interest.
ETFs, Index Funds, and Mutual Funds
If you’re in a position where you already established wealth (and are retired or near retirement), you should consider moving your money to ETFs and Index Funds because of the low expense ratio. By comparison, Mutual Funds deliver very similar returns to ETFs and Index Funds but with a higher expense ratio. If you hold Mutual Munds, a question you should ask is, why should I pay more for the same returns as an ETF or Index Fund? I only recommend staying in Mutual Funds if you like the service and peace of mind provided by your Mutual Fund Manager.
As stated in this article from The Motley Fool the average returns of the S&P 500 index are as follows.
- From 2011 – 2020 the average returns were 13.9%.
- From 1991 – 2020 the average returns were 10.7%.
- From 1971 to 2020 the average returns were 10.9%.
In summary, stocks can generate returns ranging between 15% and 50% whereas ETFs and Index Funds can generate returns that are about 10%.
Stocks = Building wealth
ETFs and Index Funds = Protecting Wealth
Mutual Funds = Protecting Wealth but with higher fees