Today’s investors have access to more products than ever. Among the most common are Mutual Funds, Exchange-Traded Funds (ETFs), and stocks. Each option can help you participate in the stock market, but they work differently and come with different costs, tax implications, and levels of personalization.
So how do you decide between Mutual Funds, ETFs and stocks? And which type of investment is right for your long-term financial strategy?
Mutual Funds and ETFs: Easy Diversification
Both Mutual Funds and ETFs pool together a basket of securities. They offer investors a certain level of diversification, which is especially valuable if you’re starting with little capital. Instead of picking companies one by one, you get exposure to a professionally constructed portfolio.
Their most significant advantage is that any investor can participate, even with a small initial amount.
Mutual Funds: Active Management with Higher Fees
Mutual Funds typically take an active investing approach, meaning professional managers select securities based on research, valuation, and long-term strategy. Active management can be useful when a fund is designed to follow a specific mandate, sector, or investment style.
However, mutual funds often have higher embedded fees, often between 2% and 3%, including management fees and other expenses. Over time, those costs can reduce performance and compound.
For example:
- A 2.5% annual fee on a $100,000 portfolio equals $2,500 per year
- As this amount is significant, you could have access to lower fees. A 1.5% annual fee on a $100,000 portfolio equals $1,500 per year – you then save $1,000 per year, on which interests will compound each year.
For investors starting with smaller amounts of capital, purchasing individual stocks while maintaining proper diversification can be difficult. In these cases, Mutual Funds can provide broad diversification through a single product, though investors should remain aware of the fees and long-term cost impact.
ETFs: A Low-Cost, Passive Way to Invest
ETFs usually take a passive approach and are designed to track an index, such as the S&P 500, the TSX, or the Nasdaq. Instead of trying to beat the market, they aim to mirror its performance. These funds hold all the companies in the index and rarely change these over time. By late 2024, more than 90% of ETFs were passive.
Because they don’t require the work that comes with active management, ETFs generally carry much lower fees than Mutual Funds, making them one of the most cost-efficient ways to invest in the stock market.
But ETFs also have drawbacks:
- They are broad, one-size-fits-all products that may not align perfectly with your personal goals.
- They can create unexpected tax distributions, even if you haven’t sold anything.
- They lack customization; everyone gets the same portfolio.
Today, you will find more and more ETFs that follow an active strategy. They’re an alternative to Mutual Funds, but their fees will be higher than passive ETFs.
Still, for long-term investors who want a simple, passive and low-cost solution, ETFs are a strong building block.
Individual Stocks: Personalized Investing for Larger Portfolios
Buying stocks directly can be one of the most powerful ways to build a tailored portfolio, especially if you have a large amount of capital and access to investment expertise.
The biggest advantages of owning individual stocks are:
- Customization: Instead of owning all 500 companies in the S&P 500, you – or your portfolio manager – can focus on the companies with the strongest financial characteristics or long-term potential. At Claret, we concentrate on the companies that offer the most attractive combination of quality, valuation, and long-term growth.
- Lower Embedded Fees: Stock portfolios avoid the extra embedded fees charged by Mutual Funds and many ETFs. Those savings can be reinvested and compound over time.
- Greater Control Over Taxation: You also gain greater control over taxes, since you decide when to buy and sell.
- Better Long-Term Efficiency: When managed well, individual stocks may deliver more efficient long-term performance, especially once you reach a level of capital where diversification is possible.
However, diversification still matters. With $10,000 or less, building a diversified stock portfolio of individual stocks is challenging. However, once you reach $100,000 or more, owning individual stocks becomes an effective way to build a personalized and tax-efficient portfolio.
Which Is Best? It Depends on Your Capital, Goals, and Strategy
In conclusion, Mutual Funds are a practical way to start investing a small amount, but you should keep an eye on the fees. For ETFs, they’re a smart choice if you want to follow a simple, low-cost, passive investment approach. Finally, individual stocks offer the highest level of personalization and long-term efficiency, provided you have access to capital and the right expertise.
Whatever option you choose, remember that successful investing in the stock market is about thinking long-term.
