Read the fine print as you comparison shop.
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If youâve explored the universe of investment strategiesâperhaps for a retirement fund, or with a financial advisorâtwo fund structures appear time and again: mutual funds and exchange-traded funds (ETFs).
When comparing ETFs versus mutual funds, youâll likely note the similarities: a wide array of choices, the ability to diversify holdings, and the convenience of a fund structure.
One reason mutual funds and ETFs seem so similar is that, when ETFs were designed a few decades ago, they were based on traditional mutual funds. Like mutual funds, ETFs invest in a portfolio of underlying securities, charge management fees, and allow investors to buy and redeem their shares on a regular basis.
Key Points
- Mutual funds and ETFs have similar structures and uses, but also a few key differences.
- ETFs, unlike mutual funds, trade throughout the day.
- Most ETFs track an index, although there are some actively managed ETFs.
- ETFs tend to have lower fees and a lower tax profile than mutual funds.
But thereâs a key difference that comes with those two words: exchange traded. With a mutual fund, you can only buy or sell once per day, at the net asset value (NAV) calculated at the close of trading.
ETFs, on the other hand, trade throughout the day like stocks. That means you can buy and sell shares in an ETF anytime the market is open. This is in stark contrast to mutual funds, which actually try to discourage active trading, often charging redemption fees on overly active accounts.
Learn more
Looking for an in-depth explanation? Refer to the Britannica Money ETF and mutual fund pages.
Another major difference is in how the funds are managed. Typically, mutual funds are actively managed by a team of professionals who design an investment strategy and make daily decisions on each security in the fund. Most ETFs are passively managed; they may follow a predetermined stock or bond index, or a sector of an index.
There are exceptions. Some mutual funds are tied to an index, and a few ETFs have an active management strategy. But in general, ETFs are passively managed products that are tied to benchmarks and set up for easy trade entry and exit.
For a full comparison, see the table below.
Mutual funds vs. ETFs: A breakdown
Here are some key factors to consider when weighing a mutual fund versus an ETF:
Mutual Funds vs. ETFs | Mutual funds | ETFs |
|---|
| Annual fees | Mutual funds charge a management fee, along with administrative fees, and may also add a 12b-1 fee for sales and marketing expenses. | Because most ETFs track an index, they tend to have lower management fees. |
| Management | Actively managed mutual funds have a portfolio manager who selects the stocks in a fund. Index funds change their holdings only when the index changes. | ETFs that track an index primarily trade to meet investor demand. But some actively managed ETFs do have portfolio managers. |
| Liquidity | You can buy and sell shares once per day. | You can buy and sell shares at any time during the trading day. |
| Pricing and settlement | The fund settles its daily trades and tallies up the value of its holdings, subtracts fees, and divides the result by the total number of shares to arrive at its net asset value (NAV) for the day. | The price is determined entirely by supply and demand for shares on exchanges, but the value tends to fall in line with the value of the securities the ETF owns. |
| Taxes | Actively managed funds tend to have more asset turnover, which generates more capital gains tax. These taxes are passed on to investors throughout the year. | In general, ETFs are more tax-efficient, as investors are required to pay taxes only on closed positions that realize capital gains. |
| Reporting | Mutual funds report their holdings, fees, and other key information through a quarterly filing with the SEC. | ETFs disclose their holdings every trading day. |
| Trading costs | You can buy mutual funds directly from a mutual fund company, often at no cost. You might pay trading fees or a sales load if you buy the fund through a broker or financial advisor. | Your broker sets the trading commission of ETFs, just as it would with stocks, bonds, or other securities. In recent years, many retail brokers have moved to a zero-commission structure for online trades. |
When deciding whether to invest in a mutual fund or an ETF, there are several factors to consider.
If you participate in a company 401(k) plan, your investment options might be limited to a few preselected mutual funds. The good news is that the sales load is typically waived.
For your remaining investment dollars, ask yourself how involved you want to be on a daily basis. For active investors, ETFs may make more sense. But casual or newer investors may prefer mutual funds for their professional guidance and management, despite the trade-offs of higher fees and less tax efficiency.
This article was most recently revised and updated by Colin DoddsThis article was most recently revised and updated by Doug Ashburn
