The Complete ETF Guide

ETFs vs. Mutual Funds: What's the Difference?

Let us first clear up the fundamental question: what exactly is an ETF, and how does it differ from a mutual fund?

ETFs and mutual funds are both investment vehicles that pool money from investors to buy a diversified portfolio. Think of them as baskets that hold hundreds or thousands of individual investments; i.e. stocks, bonds, or other securities, allowing you to own a tiny piece of each with a single purchase of the mutual fund or ETF share.

The Key Differences:

Trading Flexibility: ETFs trade on stock exchanges similarly to individual stocks, meaning you can buy and sell them anytime the market is open. Mutual funds, on the other hand, only trade once per day after markets close, with all transactions processed at the day's closing price (i.e. NAV, net asset value).

Minimum Investments: Most ETFs have no minimum investment—you can buy as little as one share and sometimes even partial or “fractional” shares. Traditional mutual funds sometimes require minimum investments of $1,000 to $3,000, though some have started offering options with no minimums.

Tax Efficiency: ETFs are generally more tax-efficient due to their structure. They create fewer taxable events through their unique redemption process, which helps minimize capital gains distributions that can create unexpected tax bills.

Fees: Both can be very low-cost, but the fee structures differ slightly. ETFs typically have lower expense ratios, especially for broad market index funds, though the differences are often minimal with providers like Vanguard, Schwab, and Blackrock. The biggest fee difference is found when you buy a mutual fund from a different brokerage (e.g. buying a Vanguard mutual fund through a Fidelity account). This can often cost you $50-100 for every transaction. Whereas you don’t pay that fee if you buy a Vanguard ETF through a Fidelity account.

Portability: Due to the fee difference and how buying outside mutual funds can cost additional money, it can be problematic to move accounts from one brokerage to another if you’re holding a lot of mutual funds that you want to continue to buy in the future. ETFs can be easily transferred from one brokerage to the next since most brokerages allow for commission-free trades on ETFs.

Index Funds vs. Actively Managed Funds

Within both ETFs and mutual funds, you'll encounter two fundamental approaches: passive index funds and actively managed funds.

Index Funds are designed to track a specific market index (like the S&P 500 or total stock market) as closely as possible. They're passive investments—no fund manager is making decisions about which stocks to buy or sell. Instead, they simply own all (or a representative sample) of the securities in their target index.

Actively Managed Funds employ professional fund managers who make active decisions about which securities to buy, sell, and hold. These managers are attempting to "beat the market" through research, analysis, and strategic trading.

The track record speaks volumes: The majority of actively managed funds underperform their benchmark index after accounting for fees. Over longer periods (10-15 years), the percentage goes up to roughly 80-90% that underperform. This is why index funds have gained such popularity—they consistently deliver market returns at very low costs. Source: https://www.spglobal.com/spdji/en/research-insights/spiva/

Cost differences are significant: Index funds typically charge 0.03% to 0.20% annually, while actively managed funds often charge 0.50% to 1.00% or more. Over decades, these fee differences compound dramatically.

Tip: For most investors, especially those building long-term wealth, index funds provide the best combination of low costs, broad diversification, and consistent market returns.

The Beauty of Starting Simple: 1-2 Fund Portfolios

One of the biggest mistakes new investors make is overcomplicating their portfolios. You can build substantial wealth with just one or two funds. Let's start with the simplest approaches:

The Ultimate Simple Portfolio

VT (Vanguard Total World Stock Index)

• Ticker Symbol: VT
• Expense ratio: 0.06%
• Holdings: 9,000+ US and International stocks
• What it does: Gives you ownership in virtually the entire world’s stock market

Alternative option:

• “VTSAX and chill” - popularized by JL Collins’ book “Simple Path to Wealth”, his belief is that you just need one fund: a US Total Stock Index Fund, like VTSAX. The ETF equivalent of VTSAX is VTI.
• Target Date Index Fund/Lifecycle Fund - this is one fund that includes nearly every stock in the world along with some allocation % to a bond index fund. These are often found in employer sponsored retirement plans like 401(k)s and 403(b)s, as an easy “set it and forget it” option. These are generally mutual funds and not ETFs, and they often have a “glidepath” where the allocation to bonds will grow over time while the allocation to stocks decreases.

The Classic Two-Fund Portfolio

Breaking up the US and International segments can create more customization and additional control during the retirement withdrawal phase.

Example Allocation: 80% VTI (US Total Stock Market) + 20% VXUS (International Stocks)

• Expense ratio: 0.03% and 0.05% respectively
• Holdings: 3,500+ US stocks and 8,500+ International stocks
• What it does: Gives you ownership in virtually the entire US and International stock markets

The Three-Fund Portfolio

Adding bonds creates the classic "three-fund portfolio" beloved by many index investors:

Example Allocation: 60% VTI + 20% VXUS + 20% BND

BND (Vanguard Total Bond Market ETF) adds:

• Stability during stock market volatility
• Predictable income through interest payments
• Low correlation with stocks during market stress (meaning bonds don’t always go up or down just because the stock market is going up/down)
• Broad exposure to US government and corporate bonds

This portfolio balances growth potential with risk management. The bond allocation provides a cushion during market downturns and can be rebalanced into stocks when they're "on sale." It helps to smooth out the volatility with the stock market if you can’t tolerate the big ups and downs.

Bond allocation guidelines:

• Age-based rule: Rule of 110 says to minus your age from 110 to determine what % of stocks you should hold (e.g. A 40yr old should hold 70% stocks and 30% bonds)
• Risk-based rule: 0-20% for aggressive investors, 40-60% for conservative investors
• Time-based rule: Higher bond allocation as you approach major financial goals

For more information, see our article on three-fund portfolios.

Getting More Sophisticated: Factor Tilting

Once you're comfortable with broad market exposure, you might consider "tilting" toward specific factors that have historically provided higher returns:

Adding Small-Cap Value

Example Allocation: 60% VTI + 20% VXUS + 20% VBR

VBR (Vanguard Small-Cap Value ETF) targets smaller, cheaper companies that are considered under-valued based on the comparison of their stock price to their earnings. This isn't about chasing hot stocks—it's about systematically tilting toward an asset class that has historically outperformed other asset classes. Source: https://www.portfoliovisualizer.com/

For more information, see my recent article on adding a small-cap value ETF to your portfolio.

Advanced Portfolios: Multiple Asset Classes

For investors who want maximum diversification, you can segment both US and International stocks and bonds while also adding real estate:

Example Portfolio With Allocations

This portfolio provides:

• Geographic diversification (US and international)
• Asset class diversification (stocks, bonds, real estate, gold, and even crypto)
• Factor exposure (small-cap value)

Practical Implementation Tips

Start Simple, Add Complexity Gradually

1. Begin with VTI
2. Add international exposure (VXUS)
3. Consider Factor tilts (VBR for small-cap value)
4. Add bonds when you want stability (BND)

Rebalancing Made Simple

• New money method: Direct new contributions to underweight assets to get back to target allocation
• Calendar method: Rebalance annually or semi-annually (remember to set a reminder)
• Threshold method: Rebalance when allocations drift 5+ percentage points from targets

Tax Considerations

• Stock index ETFs can generally be held anywhere (they're tax-efficient)
• Hold bonds and real estate in tax-advantaged accounts (they’re less tax-efficient)
• Use tax-loss harvesting within your brokerage account with similar but not identical funds to avoid wash-sale rules.

Common Mistakes to Avoid

Over-Diversification

Having 20+ funds doesn't make your portfolio better—it often makes it worse through increased complexity, higher costs, and difficult rebalancing.

Chasing Performance

Don't abandon your strategy during periods of underperformance. All asset classes have cycles of out- and underperformance.

Paralysis by Analysis

A simple portfolio implemented consistently beats a perfect portfolio that never gets started.

Ignoring Costs

Even small fee differences compound dramatically over time. A 1% annual fee can cost hundreds of thousands in retirement wealth.

Building Your Portfolio: A Step-by-Step Approach

Step 1: Assess Your Situation

• Time horizon: How long until you need the money?
• Risk tolerance: How much volatility can you handle?
• Goals: Retirement, house down payment, general wealth building?

Step 2: Choose Your Complexity Level

• Beginner: Start with VTI or VTI + VXUS (Consider adding BND for stability)
• Intermediate: Add Factor Tilts (VBR)
• Advanced: Break up stock and bond funds into smaller segments (VTV, VUG, VEA, VWO) or additional asset classes (real estate, gold, etc)

Step 3: Implement Gradually

Don't feel pressure to build the perfect portfolio immediately. Start simple and consider adding complexity as your knowledge and comfort level grow, but complexity doesn’t mean it’s better. There’s nothing wrong with keeping things simple no matter who you are.

Step 4: Automate and Stay Consistent

Set up automatic investments and resist the urge to constantly tinker. “Time in the market beats timing the market.”

The Bottom Line

The beauty of modern ETF investing lies in its simplicity and accessibility. You can build a world-class portfolio with just a few low-cost funds, accessing the same diversification and returns that were once available only to institutions.

Whether you choose a single fund like VTI or build a more complex multi-asset portfolio, the key principles remain the same:

• Keep costs low
• Stay diversified
• Invest consistently
• Think long-term
• Don't overcomplicate

Remember, the best portfolio is the one you can stick with through market ups and downs. Start simple, stay consistent, and let compound growth do the heavy lifting over time.

The alphabet soup of ETF symbols might seem confusing at first, but each represents a simple, powerful tool for building long-term wealth. Choose the approach that matches your goals, implement it consistently, and let time work in your favor.