ETFs or Mutual Funds: Which Is Right for You?

Imagine you want to invest in several companies without buying each stock individually. Two popular ways to do this are Exchange-Traded Funds (ETFs) and mutual funds.

Both allow you to spread your money across multiple investments. But they differ in how they’re traded, managed and priced.

So, which one fits your investment goals? And can both be Halal?

In this lesson, you’ll learn how ETFs and mutual funds work, their main differences and what makes them Shariah-compliant.

What do ETFs and mutual funds have in common?

Both ETFs and mutual funds pool money from multiple investors to purchase a collection of assets, such as stocks.

Instead of investing all your money in one company, you can gain exposure to several companies through a single fund.

This is called diversification. It helps spread your investment risk, although it doesn’t eliminate the possibility of losses.

The main differences lie in how these funds are traded and managed.

What is an ETF?

An Exchange-Traded Fund (ETF) is an investment fund that trades on a stock exchange, just like an individual stock.

Most ETFs track a particular index or investment strategy rather than relying on a fund manager to select individual investments.

Three important features distinguish ETFs:

• Flexible trading: You can buy and sell ETFs throughout the trading day at market prices.
• Lower fees: Many ETFs have relatively low management costs because they follow an index.
• Transparency: Many ETFs disclose their holdings daily, allowing you to see what you’re investing in.

For example, a Shariah-compliant ETF might hold shares in 100 companies that have passed Islamic financial screening.

By purchasing shares in that ETF, you gain exposure to all those companies through one investment.

What is a mutual fund?

A mutual fund also pools investors’ money to purchase a collection of assets.

However, unlike ETFs, traditional mutual funds are bought and sold at a price calculated once per trading day.

Many mutual funds are actively managed, meaning professional fund managers select investments and adjust the portfolio according to the fund’s strategy.

Their main features include:

• Professional management: Many mutual funds have managers who actively select and monitor investments.
• Daily pricing: Purchases and sales generally take place at the fund’s end-of-day net asset value (NAV).
• Management fees: Actively managed mutual funds often charge higher fees than passive ETFs.

Not every mutual fund is actively managed. Some track indexes and have relatively low fees.

ETFs vs. mutual funds: What are the key differences?

Here is a quick comparison.

Trading

• ETFs: Throughout the trading day
• Mutual funds: Generally once daily

Pricing

• ETFs: Market prices change during trading
• Mutual funds: End-of-day NAV

Management

• ETFs: Mostly passive
• Mutual funds: Often active

Fees

• ETFs: Generally lower
• Mutual funds: Can be higher

Transparency

• ETFs: Often daily holdings disclosure
• Mutual funds: Often monthly or quarterly

Minimum investment

• ETFs: Often relatively low
• Mutual funds: Varies by fund

Example: Two ways to invest $1,000

Imagine you have $1,000 and want to invest in a diversified portfolio of Shariah-compliant companies.

With a Halal ETF, you could purchase shares in a fund that tracks a Shariah-compliant stock index. You can trade its shares throughout the trading day, and the fund generally follows its index automatically.

With a Halal mutual fund, you could invest the same $1,000 in a fund managed by investment professionals. If it’s actively managed, they decide which Shariah-compliant companies to include and when to adjust the portfolio.

Both approaches offer diversification, but their costs, trading flexibility and management styles may differ.

Your $1,000 can increase or decrease in value with either option.

Can ETFs and mutual funds both be Halal?

Yes. Both can be Shariah-compliant, but neither is automatically Halal.

What matters is what the fund invests in and how it operates.

For example, a conventional ETF might hold shares in banks that earn interest or companies involved in gambling and alcohol.

A Halal ETF or mutual fund must follow appropriate Shariah screening criteria and avoid prohibited financial practices.

Two examples of funds designed for Shariah-compliant investing are the Wahed FTSE USA Shariah ETF (HLAL) and Amana Growth Fund.

Before investing in either type of fund, check its underlying holdings, screening methodology, management practices and approach to purifying non-permissible income.

Which one fits your investment goals?

The choice depends on your preferences and financial objectives.

An ETF may suit your needs if you want the flexibility to buy and sell throughout the day, prefer an index-tracking strategy or prioritize lower ongoing costs.

A mutual fund may suit your needs if you prefer professional portfolio management and don’t need to trade throughout the day.

However, both ETFs and mutual funds can be actively or passively managed. Compare the specific funds rather than relying on their names alone.

For Halal investors, Shariah compliance is another essential consideration, regardless of which fund structure they choose.

Test your knowledge

Question 1: What is the main difference between how ETFs and traditional mutual funds are traded?

• ETFs trade throughout the day, while mutual funds are generally priced once daily.
• Mutual funds trade throughout the day, while ETFs trade once a month.
• Both can only be bought after the stock market closes.

Question 2: Which statement about ETF and mutual fund management is correct?

• All ETFs are actively managed.
• All mutual funds are passively managed.
• ETFs are often passive, while many mutual funds are actively managed.

Question 3: What makes an ETF or mutual fund Halal?

• It invests in a large number of companies.
• Its holdings and operations comply with Shariah requirements.
• It charges lower management fees than other funds.

Check answers

Sources

Tabadulat | Blog | The Great Debate: ETFs or Mutual Funds? — Main content reference.

Frequently asked questions

How do ETFs and traditional mutual funds differ in trading and pricing?

ETFs trade throughout the trading day at market prices. Traditional mutual funds are generally bought and sold at their end-of-day net asset value (NAV).

Are all ETFs passive and all mutual funds actively managed?

No. ETFs are often passively managed, while many mutual funds are actively managed, but both fund types can be actively or passively managed. Some mutual funds track indexes and have relatively low fees.

Can ETFs and mutual funds both be Halal?

Yes, but neither is automatically Halal. Their holdings and operations must meet Shariah requirements. Before investing, check the underlying holdings, screening methodology, management practices and approach to purifying non-permissible income.

Does diversification through a fund eliminate investment risk?

No. Diversification helps spread investment risk but does not eliminate the possibility of losses. An investment in either an ETF or a mutual fund can increase or decrease in value.

Which fund type may fit my investment goals?

An ETF may suit you if you want trading flexibility, an index-tracking strategy or lower ongoing costs. A mutual fund may suit you if you prefer professional portfolio management and don’t need to trade throughout the day. Compare specific funds, including their costs, strategy, Shariah compliance and risks.

Related terms

• ETFs
• Mutual Funds