ETFs and mutual funds are both popular ways to invest in a diversified portfolio, but they work quite differently. Understanding these differences can help you choose the right investment vehicle for your goals and save you money in the long run. In this guide, we will compare ETFs and mutual funds across all the important factors.
What is the Main Difference?
The most fundamental difference between ETFs and mutual funds is how they trade:
ETFs trade on stock exchanges throughout the day like individual stocks. You can buy or sell at any time during market hours at the current market price.
Mutual funds only trade once per day after the market closes. All orders are executed at the same price, calculated at the end of each trading day.
Trading and Pricing
ETF Trading
ETFs offer real-time pricing and trading flexibility:
- Buy and sell anytime during market hours (9:30 AM to 4:00 PM ET)
- Use limit orders to specify your exact purchase price
- Prices fluctuate throughout the day based on supply and demand
- Can trade options on many popular ETFs
Mutual Fund Trading
Mutual funds have a simpler but less flexible trading process:
- Orders placed before 4:00 PM ET execute at that day's closing price
- Orders placed after 4:00 PM ET execute at the next day's price
- All investors get the same price for the day (Net Asset Value or NAV)
- No intraday trading or options available
Trading Example
Imagine you want to invest $5,000 when the market opens on a volatile day:
- With an ETF: You see the price is $100 per share and immediately buy 50 shares. You know exactly what you paid.
- With a mutual fund: You submit your order in the morning but will not know your purchase price until after 4:00 PM when the NAV is calculated.
Fees and Expenses
Cost is one of the most important factors when choosing between ETFs and mutual funds. Small differences in fees can add up to thousands of dollars over time.
Expense Ratios
Both ETFs and mutual funds charge an annual expense ratio, but ETFs are typically cheaper:
- Average ETF expense ratio: 0.16% (some as low as 0.03%)
- Average mutual fund expense ratio: 0.47% for index funds, 0.66% for actively managed funds
Other Fees to Consider
- Trading commissions: Most brokers now offer commission-free trading for both ETFs and many mutual funds
- Load fees: Some mutual funds charge sales loads (front-end or back-end fees) of 1% to 5%. ETFs never have load fees
- Minimum investments: Many mutual funds require $1,000 to $3,000 minimum. ETFs have no minimum beyond the price of one share
Cost Comparison Over 30 Years
Investing $10,000 with 7% annual returns:
- ETF (0.03% expense ratio): Final value of $75,700
- Mutual fund (0.50% expense ratio): Final value of $66,400
- Difference: $9,300 more with the ETF
Tax Efficiency
ETFs are generally more tax-efficient than mutual funds due to their unique structure.
Why ETFs Have Tax Advantages
When investors sell mutual fund shares, the fund manager often must sell holdings to raise cash, potentially triggering capital gains for all shareholders. ETFs use an "in-kind" redemption process that avoids this problem.
- ETFs: You typically only pay capital gains taxes when you sell your own shares
- Mutual funds: You may owe capital gains taxes even if you did not sell any shares, if the fund distributed gains
Investment Minimums
ETFs have a significant advantage when it comes to getting started:
- ETFs: You can buy as little as one share. With fractional shares (offered by many brokers), you can invest any dollar amount
- Mutual funds: Often require $1,000 to $3,000 minimum initial investment. Some funds require $10,000 or more
Investment Strategies
Passive vs Active Management
Most ETFs are passively managed, meaning they track an index. Most mutual funds are actively managed, with managers trying to beat the market.
- Passive ETFs: Lower costs, match market returns (minus small fees)
- Active mutual funds: Higher costs, may outperform or underperform the market
Important fact: Over a 15-year period, approximately 90% of actively managed mutual funds fail to beat their benchmark index. This is why many investors prefer low-cost index ETFs.
Automatic Investing
Mutual funds have traditionally been easier for automatic investing (setting up recurring purchases). However, many brokers now offer automatic ETF investing with fractional shares, eliminating this advantage.
When to Choose ETFs
ETFs may be better for you if:
- You want the lowest possible fees
- You prefer trading flexibility and real-time pricing
- Tax efficiency is important (especially in taxable accounts)
- You want to start with a small amount of money
- You prefer passive, index-based investing
- You want to trade options or use advanced strategies
When to Choose Mutual Funds
Mutual funds may be better for you if:
- You invest through a 401(k) plan (many only offer mutual funds)
- You prefer automatic investing without thinking about share prices
- You want active management and believe in a specific fund manager
- You do not need intraday trading flexibility
- The specific fund you want is only available as a mutual fund
Can You Own Both?
Absolutely! Many investors use both ETFs and mutual funds in their portfolios. A common approach is:
- Use mutual funds in tax-advantaged accounts like 401(k)s where tax efficiency matters less
- Use ETFs in taxable brokerage accounts for better tax treatment
- Choose whichever option has lower fees for the specific investment you want
Quick Comparison Table
- Trading: ETFs trade all day; mutual funds trade once daily
- Pricing: ETFs have real-time prices; mutual funds use end-of-day NAV
- Expense ratios: ETFs are typically lower
- Minimum investment: ETFs have no minimum; mutual funds often require $1,000+
- Tax efficiency: ETFs are generally better
- Automatic investing: Both options available at most brokers
Track All Your Fund Investments
Pro Trader Dashboard helps you monitor both ETFs and mutual funds in one place. See your complete portfolio allocation and track performance across all your investments.
Summary
Both ETFs and mutual funds are excellent tools for building a diversified portfolio. ETFs generally offer lower costs, better tax efficiency, and more trading flexibility. Mutual funds may be preferable for automatic investing in retirement accounts or when you want active management. The best choice depends on your specific situation, investment goals, and where you are investing. For most individual investors in taxable accounts, ETFs are the better choice due to their cost and tax advantages.
Want to learn more about specific types of ETFs? Check out our guides on sector ETFs or bond ETFs.