Overview
When you’re building an investment portfolio, you’ll quickly come across two of the most popular investment vehicles: mutual funds and exchange-traded funds (ETFs). Both allow you to invest in a diversified basket of stocks, bonds, or other assets with a single purchase, but they work quite differently from one another.
Understanding the key differences between mutual funds and ETFs can help you make smarter investment decisions and potentially save money on fees and taxes. Here’s what you need to know about each option and how to decide which one is right for your financial goals.
What are Mutual Funds?
A mutual fund is a pooled investment vehicle that collects money from many investors and uses it to buy a diversified portfolio of stocks, bonds, or other securities. When you invest in a mutual fund, you’re essentially buying a share of that entire portfolio.
Mutual funds are managed by professional fund managers who make decisions about which securities to buy and sell. Some mutual funds are actively managed, meaning the fund manager is constantly researching and trading securities to try to beat the market. Others are passively managed (often called index funds), which simply track a specific market index like the S&P 500.
One of the key characteristics of mutual funds is how they’re priced and traded. You can only buy or sell mutual fund shares once per day, after the market closes. The price you pay is based on the fund’s net asset value (NAV), which is calculated at the end of each trading day.
Most mutual funds also come with minimum investment requirements, which can range from as little as $100 to $3,000 or more, depending on the fund. Some, however, may have no such minimum.
What are ETFs?
Exchange-traded funds, or ETFs, are similar to mutual funds in that they hold a diversified basket of securities. The big difference is how they trade. As the name suggests, ETFs are traded on stock exchanges throughout the day, just like individual stocks.
This means you can buy and sell ETF shares at any time during market hours, and the price fluctuates based on real-time supply and demand. Unlike mutual funds, you don’t have to wait until the end of the trading day to know what price you’ll pay.
Most ETFs are passively managed and track a specific index, though actively managed ETFs do exist. Because they trade like stocks, you’ll need a brokerage account to buy ETFs.
There are no minimum investment requirements beyond the cost of one share, and some brokerage firms allow you to buy fractional ETF shares for as little as $1.
Key Differences Between Mutual Funds and ETFs
While mutual funds and ETFs share some similarities, several important differences set them apart:
Trading and pricing: Mutual funds can only be bought or sold once per day at the NAV calculated after market close. On the other hand, ETFs trade throughout the day at market prices that fluctuate based on supply and demand, giving you more control over the exact price you pay.
Costs and fees: ETFs generally have lower expense ratios than actively managed mutual funds because most ETFs are passively managed. Some mutual funds charge sales loads—upfront or back-end fees—while ETFs don’t have loads. That said, no-load funds are available, and low-cost index mutual funds can have expense ratios comparable to ETFs.
Tax efficiency: When you sell an ETF, the fund doesn’t have to sell any of its investments to cover your redemption because you’re selling on an exchange rather than dealing directly with the fund. But when an investor wants to redeem mutual fund shares, the fund may have to sell some of its holdings to pay them. Those sales can create capital gains taxes for the fund that get passed to all fund owners, even if you didn’t sell anything yourself.
Investment minimums: Mutual funds often require minimum initial investments, sometimes $100 or more. ETFs have no minimums beyond the price of a single share or even a fractional share, making them more accessible if you’re starting with a smaller amount of money.
Management style options: While both mutual funds and ETFs offer passive index-tracking options, mutual funds have a longer history of active management with professional managers trying to beat the market. Actively managed ETFs exist but are less common.
A Side-By-Side Comparison
| Feature | Mutual Funds | ETFs |
| When you can trade | Once daily after market close | Anytime during market hours |
| How prices are set | One price per day, calculated at close | Real-time market price; changes throughout the day |
| Minimum investment | Often $1,000 – $3,000+ | As little as $1 |
| Tax efficiency | More likely to owe taxes even when you don’t sell (when other investors cash out) | Less likely to owe taxes unless you sell (fund doesn’t need to sell holdings for redemptions) |
| Typical costs | Higher expense ratios for active funds, potential sales loads | Generally lower expense ratios, no sales loads |
| Management options | Many actively managed and passive options | Mostly passive, some active options available |
| Best for | Retirement accounts, regular automatic investments, want active management | Smaller starting amounts, want lower fees, investing in taxable accounts |
Which Is Right for You?
So how do you decide between mutual funds and ETFs? Here are some key factors to consider:
Your investment strategy
If you believe in active management and want a professional fund manager making decisions on your behalf, actively managed mutual funds might appeal to you. If you prefer a passive, buy-and-hold approach that tracks the market, both index mutual funds and ETFs can work.
How much you can invest
If you’re starting with a smaller amount of money or want to invest specific dollar amounts regularly, ETFs may be more accessible since they don’t have investment minimums beyond the share price. However, if you’re investing through an employer retirement plan, mutual funds are often your only option.
Tax implications
If you’re investing in a taxable brokerage account, the tax efficiency of ETFs can make a meaningful difference over time. ETFs’ structure means you’re less likely to face surprise capital gains distributions. If you’re investing inside a tax-advantaged account like a 401(k) or IRA, this difference doesn’t matter since you won’t pay taxes on gains until you withdraw the money.
Flexibility needs
If you want the ability to buy and sell throughout the trading day, ETFs give you that flexibility. If you’re a long-term investor who doesn’t need intraday trading, the once-daily pricing of mutual funds shouldn’t be a drawback.
Preferred management style
Some investors prefer the potential for outperformance that comes with active management, even though it comes with higher fees and no guarantee of beating the market. Others prefer to simply match the market’s returns through low-cost passive investments.
The Point
Neither mutual funds nor ETFs are inherently better than the other. The right choice depends on your individual goals, budget, investment strategy, and where you’re investing.
Mutual funds are more likely to offer the benefit of professional active management options and work well for retirement accounts and automatic investment plans. In contrast, ETFs provide trading flexibility, lower costs, and better tax efficiency for taxable accounts.
If you’re unsure which option is best for your situation, consider talking to a financial advisor who can look at your complete financial picture and help you make the right decision. Remember, both mutual funds and ETFs can play an important role in building a diversified, long-term investment portfolio.
by your friends at The Daily Navigator
