They’re similar—but they’re different in some very key ways. We’ll help you compare.
Biggest similarity: both represent managed "baskets" or "pools" of individual securities, for example stocks or bonds.
ETFs (exchange-traded funds) and mutual funds both offer exposure to a wide variety of asset classes and niche markets. They generally provide more diversification than a single stock or bond, and they can be used to create a diversified portfolio when funds from multiple asset classes are combined.
While they can be actively or passively managed by fund managers, most ETFs are passive investments pegged to the performance of a particular index.
Mutual funds come in both active and indexed varieties, but most are actively managed. Active mutual funds are managed by fund managers.
ETFs trade like stocks and are bought and sold on a stock exchange, experiencing price changes throughout the day. This means that the price at which you buy an ETF will likely differ from the prices paid by other investors.
Mutual fund orders are executed once per day, with all investors on the same day receiving the same price.
Because they trade like stocks, ETFs do not require a minimum initial investment and are purchased as whole shares. You can buy an ETF for the price of just one share, usually referred to as the ETF’s “market price.”
Minimum initial investments for mutual funds are normally a flat dollar amount and aren’t based on the fund’s share price.
ETFs have implicit and explicit costs. While your broker will disclose the cost of trading commissions and the ETF provider will disclose the operating expense ratio, don’t overlook the bid/ask spread and premium/discount to NAV. These costs are implicit and result from buying or selling an ETF in the market at a price which may differ from the value of the ETF’s underlying holding.
Mutual funds can be purchased without trading commissions, but in addition to operating expenses they may carry other fees (for example, sales loads or early redemption fees.
ETFs often generate fewer capital gains for investors since they may have lower turnover and can use the in-kind creation/redemption process to manage the cost basis of their holdings.
A sale of securities within a mutual fund may trigger capital gains for shareholders—even for those who may have an unrealized loss on the overall mutual fund investment.
While they can be actively or passively managed by fund managers, most ETFs are passive investments pegged to the performance of a particular index.
Mutual funds come in both active and indexed varieties, but most are actively managed. Active mutual funds are managed by fund managers.
ETFs trade like stocks and are bought and sold on a stock exchange, experiencing price changes throughout the day. This means that the price at which you buy an ETF will likely differ from the prices paid by other investors.
Mutual fund orders are executed once per day, with all investors on the same day receiving the same price.
Because they trade like stocks, ETFs do not require a minimum initial investment and are purchased as whole shares. You can buy an ETF for the price of just one share, usually referred to as the ETF’s “market price.”
Minimum initial investments for mutual funds are normally a flat dollar amount and aren’t based on the fund’s share price.
What are the costs?
ETFs have implicit and explicit costs. While your broker will disclose the cost of trading commissions and the ETF provider will disclose the operating expense ratio, don’t overlook the bid/ask spread and premium/discount to NAV. These costs are implicit and result from buying or selling an ETF in the market at a price which may differ from the value of the ETF’s underlying holding.
Mutual funds can be purchased without trading commissions, but in addition to operating expenses they may carry other fees (for example, sales loads or early redemption fees.
ETFs often generate fewer capital gains for investors since they may have lower turnover and can use the in-kind creation/redemption process to manage the cost basis of their holdings.
A sale of securities within a mutual fund may trigger capital gains for shareholders—even for those who may have an unrealized loss on the overall mutual fund investment.
That all depends on your goals and the type of investor you are.
Intraday trades, stop orders, limit orders, options, and short selling—all are possible with ETFs, but not with mutual funds.
ETFs and index mutual funds tend to be generally more tax efficient than actively managed funds.
And, in general, ETFs tend to be more tax efficient than index mutual funds.
If you make regular deposits—for example, you use dollar-cost averaging—a no-load index mutual fund can be a cost-effective option, and it allows you to fully invest the same dollar amount each time (since mutual funds can be purchased in fractional shares).
When you buy or sell ETF shares, the price may be less than the net asset value (or, NAV) of the ETF. This discrepancy (aka: the “bid/ask spread”) is often nominal, but for less actively traded ETFs, that might not always be the case.
By contrast, mutual funds always trade at NAV, without any bid/ask spreads.
People invest in actively managed mutual funds in hopes they’ll surpass their benchmarks.
Also, actively managed funds acquired as part of a specific strategy may complement index funds in a portfolio, and help to reduce downside risk and mitigate market volatility.
Some markets are “highly efficient”—which means they’re so popular, there isn’t much opportunity to add any real value via active portfolio management.
But in less efficient markets–like high-yield bonds or emerging markets–there may be greater opportunities through active portfolio management.
Explore additional topics in our Understanding ETFs and Mutual Funds Insights sections:
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