ETFs vs funds: difference and correct use explained

ETFs, funds and index funds, which are rarely used by private investors, are often lumped together. However, there are actually significant differences that can dramatically affect your overall return! The following guide explains the differences between ETFs and funds and when which product is more suitable.

Differences between ETF vs. fund

Exchange traded funds (also known colloquially as ‘index funds’) have captured the hearts of investors in recent years and have taken a large share of the market away from traditional investment funds. No wonder, since they generate only a fraction of the costs of other investment products and offer extensive strategic possibilities with thousands of variants!

If you invest in such an ETF, you acquire shares in all the shares it contains (products with cryptocurrencies, bonds and other assets are also available). That’s nothing special at first. Investment funds, for example, work on exactly the same principle.

The differences between ETFs and funds lie in the trading centre and the composition! Exchange traded funds are, as the name suggests, traded on a stock exchange. You can buy and sell them at any time during opening hours. Access is via any broker such as Scalable Capital or Trade Republic.

I have summarised for you which provider is particularly suitable for trading in my article ‘Broker comparison’.

Investment funds, on the other hand, cannot be found on a stock exchange; instead, you can buy them directly from the respective fund company or a bank and sell them again.

The second key difference is the composition, or more precisely: who decides which assets go into the respective investment product in the case of ETFs and funds? In the case of investment funds, a team of qualified fund managers takes on this task. You select the appropriate shares, bonds and other investments.

In doing so, they endeavour to achieve the objectives of the respective investment fund, such as return or asset protection, in the best possible way. Of course, they are paid for this work, which explains the very high costs of these investment products.

An ETF, on the other hand, is an index fund, i.e. it automatically replicates an existing list of stocks (index). The best-known indices include the DAX (‘Deutscher Aktien Index’, the shares of the 40 largest German companies) and the S&P 500 (the shares of the 500 largest US stock corporations).

Thousands of such lists are available and can serve as a basis. As they are modelled without the involvement of fund managers, the costs are also only a fraction of what they would be, which has contributed greatly to the success of these products in recent years.

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mutual funds

The idea behind investment funds is as simple as it is ingenious: to maximise your success in the financial world, you need the right amount of capital. But what if you don’t have millions of euros lying around? You can team up with other investors! Such joint assets were first created 250 years ago.

This makes investment funds something like the granddaddy of the fund world. Many investors put their assets in the hands of specialists. They have the task of utilising the capital in their interests. The primary objective is to achieve a return. Ideally more than would be possible with other investment products.

Unfortunately, this is almost never the case in practice – investment funds almost always achieve a poorer return than a comparable index, partly due to the high costs:

• A one-off fee is charged at the time of purchase. This is usually around 5% of the order volume, but can also be significantly higher in individual cases.
• Every year you will incur further expenses. The running costs are generally between 1 and 2 %. To determine the return on a fund, you have to deduct it from the profits.

The performance of the well-known Franklin Technology Fund (blue) compared with the MSCI World Information Technology Index (turquoise) shows that investment funds generally deliver poorer returns.

Despite their predominantly poor performance, investment funds remain very popular. The main reason for this is intensive marketing: banks and supposedly independent financial advisors are very keen to recommend these products, as they receive a high premium when they take out a policy.

But not only the marketing strategy, but also many funds themselves are very opaque! It is not always entirely clear how individual products end up in the investment funds or how their price is made up.

This is because you cannot buy these products on the stock exchange, but have to contact the issuer or a bank. Transactions can therefore take a while, but should usually be executed on the same working day.

Through political influence, these funds have also become an important part of our economic system. As a central component of all pension and life insurance policies, they have found their way into the portfolios of more than 50 million Germans.

But investment funds don’t automatically have to be bad! Some of the offers provide advantages that you will hardly find with any other investment or serve a specific niche. For example, you can find special hedging funds designed to protect you from price slumps in times of crisis. In addition, there are always some products that actually offer an attractive return – after deducting all costs.

Exchange Traded Funds.

In the comparison between ETFs and funds, exchange-traded funds are clearly the more favourable and flexible option. However, as there is no experienced fund manager managing the investments for you, the potential risk is also greater! If you choose the wrong index fund, you risk corresponding price losses.

The large selection can quickly overwhelm newcomers in particular. A good starting point is a world ETF based on the MSCI World Index, which tracks around 1,500 companies from 23 industrialised nations, allowing you to benefit from the growth of the global economy in a very diversified way. You can find the most lucrative offers in my article ‘Best MSCI World ETF’.

Such share ETFs are also the best-known representatives of this asset class. They each contain dozens to thousands of securities. Bonds, cryptocurrencies, commodities, precious metals and property are also available.

They are all based on indices, i.e. lists of assets published by financial companies or rating agencies such as Standard and Poor’s. Such compilations can be based on the following aspects, for example:

• Market capitalisation, i.e. how much a company’s shares are worth in total. Lists of the largest companies, such as the S&P 500 (the 500 US companies with the largest market capitalisation), are particularly popular. However, medium-sized (‘mid cap’) and small (‘small cap’) companies are also listed in their own indices.
• Region. You can invest in as many countries as possible via a global ETF or focus on individual markets such as Europe, North America or Asia. This principle can be broken down to country level, for example with a Germany ETF or UK ETF.
• Industry. With so-called sector ETFs, you can invest specifically in one field, such as the financial sector, the semiconductor industry or Consumer Staples.
• Term for bond ETFs, e.g. short-term (maximum remaining term of 2 years) or long-term (remaining term of more than seven years).

The SPDR S&P 400 US Mid Cap UCITS contains 400 US companies with a mid market capitalisation

Trading takes place via your broker. For example, I prefer to use Freedom24 and have written a special report on my Freedom24 experience. There are no additional costs for the purchase (apart from the brokerage fees), so the ETFs vs. funds start directly with an enormous price advantage.

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Points

Up to 20 free shares (until 28.02.2025)

15 trading venues, 1,500+ ETFs, 40,000+ shares

Median of €79 - €529 of free shares (until 28.02.2025)

TO THE PROVIDER*

The annual costs are also significantly lower and are less than 0.5 % in most cases. Overall, a fund replicates the underlying index very favourably and is therefore potentially very lucrative. However, the actual performance always depends on the particular market that an exchange-traded fund is replicating!

If the US economy loses momentum, for example, shares in the S&P 500 will also lose value. A fund that replicates this share index then also records price losses. As there is no fund manager to compensate for these dips by hedging or buying other shares, these price changes have a direct impact on your portfolio.

The performance of the underlying index therefore determines how well an exchange-traded fund performs.

Index funds

We actually want to look at the difference between ETFs and funds, but the category of index funds also needs to be mentioned. They lead a shadowy existence in Germany, as for a long time they were only available to professional dealers. Private individuals have only recently been able to acquire shares.

As with exchange-traded funds, index funds are also based on an index, which they replicate as closely as possible by purchasing the respective shares or other assets. However, you cannot trade them on a stock exchange, but have to buy or sell them directly from the respective fund company or a bank.

Their price (the sum of all the assets they contain) is calculated once a day, after the close of trading on the exchanges, and all investor purchases and sales are then settled – trading once a day is not exactly customer-friendly. At least the costs are comparatively low.

In the ETF vs. fund comparison, index funds therefore combine the concept of ETFs (index tracking) with the inflexible handling of investment funds. As the two competitors each have strong advantages, most private investors are not interested in index funds.

Are ETFs or funds better?

The difference between ETFs and funds is clear: the former track an index passively and cost-effectively, while the latter are actively managed at high cost. That means the index funds are better, right? It’s not quite that simple! Both forms have their raison d’être.

ETFs are clearly the most attractive asset class for most private investors. You get excellent diversification here, as you acquire dozens of shares or other assets with one fund. At the same time, your running costs remain low and hardly affect your return.

The large selection of indices with their special characteristics is particularly exciting – almost any strategy can be implemented in this way. Thanks to the stock exchange listing, even active trading, the use of leverage and shorting via short selling is possible!

The special advantages and disadvantages of ETFs make these investment products an ideal tool for long-term wealth accumulation, and short-term price slumps – for example due to stock market crashes and recessions – do not play a role in multi-year strategies. ETF retirement provision or building up a passive income are particularly exciting concepts that appeal to many investors.

An ETF portfolio is a sensible basis for your finances and an ideal starting point for beginners. You can later expand such a foundation with additional investment products such as P2P loans, cryptocurrencies or individual shares to further customise your portfolio to your needs.

In contrast, investment funds are hardly suitable for such a broad investment. The costs are simply too high and usually result in disappointing performance in practice. It is therefore all the more bizarre that they have found their way into pension and life insurance policies …

However, the funds shine in special roles that hardly any other financial product can fulfil. These include, for example, complex investment strategies and investments with focal points that you can hardly implement yourself. The ‘Schroder International Selection Fund Greater China’, for example, offers access to Chinese shares – a market that is almost impossible for us European private investors to penetrate.

Schroder International’s Greater China Fund (turquoise) not only offers access to a market that is difficult for us investors to master; it also performs better than a comparable ETF (gold)

An actively managed fund can also make sense for people with large assets and a correspondingly extensive portfolio. A high-quality product can provide additional stability and can therefore be a good choice for a (manageable) portion of the capital.

93/100

Points

Up to 20 free shares (until 28.02.2025)

15 trading venues, 1,500+ ETFs, 40,000+ shares

Median of €79 - €529 of free shares (until 28.02.2025)

TO THE PROVIDER*

Conclusion: ETF vs. fund difference in costs, purpose and performance

A comparison of ETFs vs. funds reveals a number of similarities, but also dramatic differences: both investment products represent a basket of shares, commodities, cryptocurrencies, bonds or other assets, and if you invest your money in such a construct, you acquire shares in all the assets it contains.

The key difference, however, is how this content is selected: exchange-traded funds passively track a prefabricated list (index), while investment funds are actively managed by financial experts. The active variant incurs high costs that significantly reduce your return. The passive form, on the other hand, is much more favourable; however, success also depends largely on your own choice.

In most cases (e.g. long-term wealth accumulation, retirement provision, sensible investment for private investors), exchange-traded index funds are probably the better choice. They almost always outperform the results of fund managers, which is mainly due to the significantly lower costs.

However, investment funds can be worthwhile as part of your overall strategy. Some niches of the financial market can be tapped very well and with little effort using such products.

However, investment funds no longer seem to be in keeping with the times due to their generally moderate performance and high costs. In the competition between ETFs and funds, the former are clearly ahead of the latter, so it is not surprising that index funds are taking an increasingly large share of the market and are a popular tool for implementing an equity pension, dividend strategy or wealth accumulation.

FAQ – Frequently asked questions about ETF vs. funds