A couple of things have prompted me to write this article explaining the differences worth knowing between an ETF vs a Fund.
For those of you that read this blog regularly you’ll know that I switched platform to Hargreaves Lansdown recently which caused me to sell my Global All Cap Fund and swap it for VWRP (an ETF) because of HL’s fee structure.
I also recently wrote a post comparing the difference between VWRP vs Global All Cap Fund. I didn’t want to expand/complicate that article considerably by explaining the difference between a Fund and an ETF but I did want to cover the subject separately for those of you that are newer to the world of investing and left wondering.
Table of Contents
What is an ETF
ETF’s, which stands for Exchange Traded Fund, are classed as shares and are therefore bought and traded on the open market just like any other share.
Most ETFs are Passive Index Trackers i.e. they track an Index such as the S&P 500 rather than being Actively managed.
What is a Fund
I’m going to simplify this to save you a headache. Funds come in various types and you’ll see lots of different terms banded about; OEIC, Unit Trust, Mutual Fund, Index Fund etc.
As a UK investor, you are mainly going to come across OEIC’s which stands for open-ended investment company. They are what Americans call Mutual Funds.
You get Index Funds (simply meaning they track an Index such as the FTSE Global All Cap Index) and you get Actively Managed Funds (meaning the Fund manager is choosing the underlying investments).
Does it matter whether I pick an ETF vs a Fund
Let’s start with the most obvious question and that is does it really matter if the fund you want to invest in is an ETF or a Fund?
Although ETFs and Funds are technically very different investment structures in terms of how they are traded, priced etc. in most cases, for the purposes of investing for FIRE, then it doesn’t matter which you choose, but there are a few key differences worth considering.
Investment Platform Charges
What forces most people’s hand when choosing between a Fund and an ETF is the fee structure of your chosen investment platform.
Platforms such as Hargreaves Lansdown & Fidelity charge an uncapped % fee for holding Funds, whereas they cap their fees for holding ETFs. If you are using a platform that charges this way then you would be better off going for an ETF rather than a Fund.
To put this point into sharp focus let me give you an example based on my personal experience.
I recently moved from Interactive Investor to Hargreaves Lansdown but before I did I sold my holding in the Vanguard FTSE Global All Cap Fund and bought the nearest equivalent ETF (VWRP).
Why? Because if I had kept the Global All Cap fund Hargreaves Lansdown would have charged me £922 per year just for that one holding instead of the capped ETF fee of £45. That is a huge difference.
Investment Platform Lack of Choice
Some platforms, namely the newer startup/challenger ones such as Trading 212, InvestEngine, FreeTrade etc. don’t offer Funds at all. You can only buy ETFs on these platforms. So again, in this case, your hand is forced by platform choice.
ETF vs Fund – Pricing
ETFs work just like an ordinary share in that they are live priced and they have a bid price and an offer price. The price you see on the screen is the price you can buy or sell at. If you sell an ETF the proceeds usually appear in your account the same day.
Funds work differently. They are valued once per day (sometimes at midday, sometimes after the market closes). When you buy or sell you don’t actually know the exact price you will get until the next day. If you’re selling it takes a couple of days before you receive the proceeds in your account.
Fractional Shares/Units
This is something to bear in mind if you are only investing a small amount per month i.e. £25.00 to £75.00 ish.
In the 2023 Autumn Statement, the Treasury announced its intention to allow fractional shares to be held within an ISA. Here’s the exact wording from the Autumn Statement:
5.43 ISA: Allowing certain fractional shares contracts as a permitted investment – The government intends to permit certain fractional shares contracts as eligible ISA investments and will engage with stakeholders on implementation.
Given the rules around fractional shares are still to be finalised, most platforms don’t yet offer the functionality. (although some have jumped the gun and introduced them, which the FCA have warned them against https://www.fca.org.uk/firms/fractional-shares)
The reason for mentioning this is that it matters if you are only investing a small amount per month and you are buying an ETF.
Let’s assume you are choosing between VWRP vs Global All Cap Fund (the former is an ETF the latter is a Fund (OEIC) and are very similar investments).
The current price of VWRP is £100.00 per share and the current price of VAFTGAG (Vanguard FTSE Global All Cap Fund) is £207.03.
So if you are investing less than £100 per month, you will have to wait until you have at least £100 saved up in your account before you can buy 1 share of VWRP. If you’re only investing £25 per month, that means you’ll be waiting 4 months before you can actually invest and you’ll only be investing 3 times per year, which is not great.
However, if you opted for VAFTGAG instead you would be investing each month because you can buy a fraction of a unit in a Fund. Although most platforms have a minimum investment amount per month (ranging from £25-£100 depending on platform), which is something else to watch out for.
ETF vs Fund Summary
I have tried to stick to the salient things to know when choosing between an ETF vs Fund and skipped over what I feel are unnecessary technicalities that don’t matter to the average FIRE investor.
As I mentioned toward the beginning of the article in many ways it doesn’t make any difference whether you are using an ETF or a Fund but there are a few gotchas to look out for, excessive platform fees being the big one.
I used to buy either without caring a jot because I was using Interactive Investor which doesn’t charge extra for Funds, but now I’m on Hargreaves Lansdown which does I just stick to ETFs.