Mutual Funds Or ETFs: Which Asset Class Should You Choose?

This article is written in collaboration with FSMOne.com. Views expressed in the article are the independent opinion of DollarsAndSense.sg.

Mutual funds (also known as Unit Trusts) and Exchange-Traded Funds (ETFs) are two common asset classes that many investors would use in order to enjoy diversification in their investment portfolios.

Both mutual funds and ETFs are similar in the sense that they pool together money from many small retail investors to create a fund. This fund, which is managed by a professional fund manager, would make investment decisions on behalf of investors to achieve the fund objective.

What’s The Difference Between Investing In A Mutual Fund Or An ETF?

The key difference between mutual funds and ETFs lie in their approach.

ETFs are generally passive in nature. For many index-based ETFs, the fund managers’ job is to track the performance of the index. Fund managers for index-based ETFs do not have the discretion to make trades based on what they think could perform better.

For most mutual funds, the investment objective is to be able to outperform the benchmark index and to deliver higher returns to their investors as compared to what they may get if they invest via an index-based ETF.

Before deciding to invest in one type of asset class over another, it’s important for you to first understand the advantages of either option.

The Advantages Of Using ETFs

ETFs have become very popular for investors in recent years because of a few key advantages.

Lower cost: ETFs are a good, low-cost option for investors who want diversification into a particular market or sector. Typically, you would expect ETFs to have an annual management fee of 0.5% or less.

Thematic investing: If you are looking to invest in specific sectors, ETFs are a good way to get broad exposure to the sectors that you are looking at. By investing in just one ETF, you are able to enjoy exposure to the entire sector. Examples would include REITs, Semiconductors, Chinese banks.

FSMOne.com has an ETF Focus List which can help new investors identify the right ETFs for them to get started on their investing journey. With a very competitive 0.08% commission fee, you are also able to invest in ETFs at the lowest possible cost. You can also read about how they select the best ETFs (and how you can do it too).

Traded on a stock exchange: As its name suggests, ETFs are listed and can be bought and sold on stock exchanges, similar to stocks and bonds. This allows investors to buy and sell units of their ETFs throughout the trading day.

Passive approach towards investing: One way to think about ETFs is that they are similar to robots, designed to do exactly what they are programmed to do. For example, if an ETF is meant to track the performance of a market index (e.g. STI ETF), then you should expect your ETF to deliver similar returns to how the market index has performed.

Read Also: Investing In Hong Kong, China and USA: Here Are 7 ETFs Which You Ought To Know About

If you want to learn more about how you can invest in ETFs, you can start by reading up more about ETF investing ideas. FSMOne.com does regular write-ups about ETF investing and this would be a good place to start doing your research from.

The Advantages Of Using Mutual Funds

While some investors may choose to use ETFs to get started on investing, they are not without their limitations. This is where mutual funds are able to address some of the challenges that investors may face when investing in ETFs.

Ability to outperform the market: ETFs which track the market index would deliver returns similar to the market. What this also means is that if stocks within the index don’t perform well, neither would the ETFs that track it.

On the other hand, a good fund manager that is able to pick strong performing stocks would be able to outperform the index and thus, any ETFs that track the index.

The FSM Recommended Funds Report is an annual publication of FSMOne.com. It serves as a tool and guide in helping investors choose the right funds that they can invest into. Funds are recommended based on a strict methodology that takes into account performance, expenses ratio, ability to mitigate the effects of a market decline and FSM assessment of whether the fund’s strategy will work favorably for investors given their views of the market.

If you are looking to select the right mutual funds that can potentially deliver better risk-adjusted returns, this would be a useful tool for you to rely on to find some mutual funds, which the FSMOne.com research team has identified as funds that could perform well. FSMOne.com also provides a risk rating for each of these funds and a write-up on why they like the funds which they are recommending.FSMOne.com does not have any sales charges for unit trust that it distributes to investors.

Able to choose markets and sectors that do not have any ETFs: One of the main reasons to use mutual funds to invest in markets and/or sectors that you are looking at is simply because there may not be a suitable ETF available to invest in.

Growth stocks: Growth stocks have the potential to grow quickly – and more importantly, faster than their peers. Another drawback of ETFs is that they typically consist of stocks based on their market capitalisation and past performance, rather than future growth prospects. This means ETFs tend to be exposed to large companies that may have already seen their best periods of growth.Fund managers of mutual funds on the other hand, can decide to choose the right growth companies that they believe would perform well based on their analysis.

Multi-Asset Strategies: Asset allocation is an important component of investing. This means investors should look towards investing in both stocks (for growth) as well as bonds (for stability) in their portfolio. When you invest in an ETF, you are only going to get exposure to one asset class (usually stocks). Multi-Asset mutual funds give you the option of having a portfolio which comprises of both stocks and bonds, among other asset classes.

One good example of a Multi-Asset Fund as recommended by FSMOne.com is Schroder Multi-Asset Revolution. The fund, which is also CPFIS-SA approved, is an actively managed basket of equities, fixed income, property and commodities related securities in global markets. This gives investors diversification across asset classes globally, and when the need arises, active management of their asset allocation. There isn’t a practically equivalent ETF that replicates this strategy.

Are ETFs Better Than Mutual Funds? Or Vice Versa?

An investor that wants to invest in the long-term performance of the S&P 500 or Straits Times Index (STI) can easily find ETFs which track these indexes. However, this does not mean that he should invest only in ETFs for all markets and sectors.

For example, if you want to invest in technology companies, given that many high-performing companies over the past decade have been from this sector, you may want to consider investing via a mutual fund that specialises in technology companies.

This is because professional fund managers have the access to more information and are able to react quicker, an advantage which is incredibly important for the fast-paced technology sector, where companies can take great strides or face setbacks in a short time span. Case in point would be the contrasting fortune of Nokia and Apple after the iPhone was first launched.

You can also use the fund selector tool created by FSMOne.com to find funds according to the categories provided. This allows you to compare funds in each category against each other to determine which is best in class performance wise.

One way to see if the funds that you are selecting is faring better than the benchmark that it is comparing itself against is to use Chart Centre, which is a tool also offered by FSMOne.com.

ETFs & Mutual Funds Can Complement One Another

We can (and should) have a mix of stocks, bonds, funds and even cash within our investment portfolio. Similarly, choosing ETFs or mutual funds is not mutually exclusive. There is room for both asset classes in our investment portfolio.

Depending on which markets and sectors we want to invest in, and how the ETFs and funds in these markets and sectors are constructed, it’s perfectly fine to have a combination of ETFs and mutual funds in our portfolio when we invest.

There are plenty of platforms in Singapore for investors to choose from when it comes to investing in ETFs or mutual funds. A platform such as FSMOne.com  not only offers a wide selection of ETFs and mutual funds, but also resources to help you choose the ones that in their view, are most likely to help you profit.

The selection of ETFs and mutual funds on FSMOne.com isn’t just restricted to investments in Singapore, but overseas ETFs and mutual funds as well. Exposure to overseas markets provides your portfolio with global diversification, and also allows you to invest in quality companies that are not listed on the SGX.

Besides ETFs and mutual funds, FSMOne.com users can also choose to invest directly in stocks, bonds and purchase insurance policies to protect themselves. And if you are not sure on how to start investing, you can also get started using FSMOne.com’s online Managed Portfolio Service called “FSM MAPS” that builds, monitors and balances your portfolio for you automatically.

Read Also: Why Asset Allocation Is The No.1 Thing Investors Don’t Think About…But Should