For Canadian homeowners looking to grow their wealth, understanding the differences between exchange-traded funds (ETFs) and mutual funds is essential to understanding how the stock market works. Both investment vehicles offer diversification and professional management, but their structures, costs, and strategies differ significantly. This guide will help you navigate these two options to make informed financial decisions in 2025.

What Are ETFs and Mutual Funds?

Exchange-Traded Funds (ETFs)

ETFs are baskets of securities (e.g., stocks, bonds) that trade on stock exchanges like individual stocks. They aim to replicate the performance of an underlying index, sector, or asset class.

The iShares S&P/TSX 60 Index ETF tracks the performance of 60 large Canadian companies.

Key Feature: ETFs trade throughout the day at market prices, making them highly liquid.

Mutual Funds

Mutual funds pool money from multiple investors to purchase a diversified portfolio of assets, typically managed by a professional fund manager.

A mutual fund like the RBC Balanced Fund may invest in a mix of Canadian stocks and bonds to achieve moderate growth.

Key Feature: Mutual funds are traded at the end of the trading day, and their price is based on the fund’s net asset value (NAV).

Key Differences Between ETFs and Mutual Funds

1) Cost Structure

ETFs:

Lower management fees, with expense ratios typically ranging from 0.05% to 0.75% annually.

Trading costs, such as brokerage fees, apply when buying or selling shares.

Investing $10,000 in an ETF with a 0.10% expense ratio costs $10 annually.

Mutual Funds:

Higher management fees, with MERs (Management Expense Ratios) averaging 1.5% to 2.5%.

Front-end or back-end loads (sales charges) may apply.

Investing $10,000 in a mutual fund with a 2% MER costs $200 annually.

2) Trading Flexibility

ETFs:

Traded like stocks during market hours, allowing for real-time pricing.

Ideal for active investors who want control over timing.

Mutual Funds:

Traded at the end of the trading day based on NAV.

Better suited for long-term, buy-and-hold investors.

3) Management Style

ETFs:

Primarily passive, tracking an index or specific market segment.

Lower fees due to minimal active management.

Mutual Funds:

Actively managed, with fund managers making investment decisions to outperform the market.

Higher fees reflect the cost of active management.

4) Minimum Investment Requirements

ETFs:

No minimum investment; you can purchase a single share.

Fractional shares are available with some brokers, making ETFs accessible.

Mutual Funds:

Often have minimum investment requirements, typically starting at $500 to $5,000.

5) Tax Efficiency

ETFs:

Generally more tax-efficient due to their structure, minimizing capital gains distributions.

Suitable for taxable accounts.

Mutual Funds:

Higher likelihood of capital gains distributions, which can trigger taxes even if you haven’t sold the fund.

More tax-efficient when held in registered accounts (e.g., RRSP, TFSA).

Advantages and Disadvantages of ETFs & Mutual Funds

Advantages of ETFs

Low cost: Expense ratios are much lower than mutual funds.

Flexibility: Real-time trading allows for active strategies.

Transparency: Holdings are disclosed daily.

Tax efficiency: Fewer taxable events compared to mutual funds.

Disadvantages of ETFs

Trading costs: Frequent trading can add up.

Limited active management: Primarily passive strategies may underperform in volatile markets.

Investor discipline required: Liquidity can tempt frequent trading.

Advantages of Mutual Funds

Professional management: Actively managed funds aim to outperform benchmarks.

Automatic contributions: Many mutual funds offer systematic investment plans.

Suitable for beginners: Long-term focus aligns well with inexperienced investors.

Disadvantages of Mutual Funds

High fees: MERs and potential sales charges reduce returns.

Lack of transparency: Holdings are disclosed quarterly, not daily.

Trading restrictions: Only traded at day’s end, limiting flexibility.

Choosing the Right Option: ETFs vs. Mutual Funds

Consider ETFs If You:

Prefer low-cost, passive investments.

Want the flexibility of trading throughout the day.

Have a self-directed investment account with a discount broker.

Are comfortable managing your portfolio.

Consider Mutual Funds If You:

Value professional management and active strategies.

Prefer a hands-off approach.

Use financial advisors who recommend mutual funds.

Are investing small amounts regularly through a systematic plan.

Mathematical Comparison: The Impact of Fees

Scenario: Investing $10,000 for 20 years with an average annual return of 6% before fees.

ETF (0.20% Fee):

Annual fees: $20 ($10,000 × 0.002).

Portfolio value after 20 years: $31,808.

Mutual Fund (2% Fee):

Annual fees: $200 ($10,000 × 0.02).

Portfolio value after 20 years: $22,996.

Difference: The ETF investor earns $8,812 more, highlighting the significant impact of lower fees over time.

ETFs and Mutual Funds in Registered Accounts

Both ETFs and mutual funds can be held in registered accounts such as RRSPs and TFSAs, offering tax advantages:

RRSPs: Contributions reduce taxable income, and investments grow tax-deferred. Withdrawals are taxed as income.

TFSAs: Investments grow tax-free, and withdrawals are not taxable.

Pro Tip: Use ETFs for low-cost growth and mutual funds for diversification in professionally managed portfolios.

Top Brokers for ETFs and Mutual Funds in Canada

Wealthsimple Trade: Commission-free ETF trading with no account minimums.

Questrade: Low fees for ETF purchases and a broad selection of mutual funds.

RBC Direct Investing: Access to a wide range of mutual funds and ETFs with excellent research tools.

BMO InvestorLine: Competitive pricing for both ETFs and mutual funds.

Learn the Difference Between ETFs vs. Mutual Funds

The choice between ETFs and mutual funds depends on your investment goals, risk tolerance, and financial situation. ETFs are ideal for cost-conscious investors seeking flexibility, while mutual funds are better suited for those who prefer active management and long-term strategies.

By understanding the strengths and limitations of each, you can build a diversified portfolio that aligns with your financial objectives. Consult with a financial advisor to ensure your investment strategy is tailored to your needs, and always consider fees, performance, and tax implications before making a decision.