ETF vs. Mutual Fund: What's the Difference?

ETF vs. Mutual Fund: An Overview

An investor's portfolio may include stocks, bonds, and sectors with value or growth options, and investors commonly decide whether a mutual fund or exchange-traded fund (ETF) meets their financial goals.

Mutual funds and ETFs can hold portfolios of investments like stocks, bonds, or commodities. They both adhere to the same regulations, like what they can own or how much can be concentrated in one or a few holdings.

Both can be good options for investors but have some key differences that make one better suited than the other concerning an investor's investment goals.

ETFs

Exchange-traded funds trade on exchanges just like common stocks. Most ETFs are index-tracking and aim to match the returns and price movements of an index, such as the S&P 500, by assembling a portfolio that matches the index constituents.

Passive management generally makes ETFs cheaper than mutual funds with lower expenses than index-tracking mutual funds. Because buyers and sellers are doing business with one another, the managers have far less to do. The ETF providers want the price of the ETF to align as closely as possible to the net asset value of the index. To do this, they adjust the supply by creating new shares or redeeming old shares.

Mutual Funds

Mutual funds are commonly managed by financial institutions such as Vanguard, T. Rowe Price, and BlackRock, either directly or through a brokerage firm. The purchase of a mutual fund is executed at the net asset value of the fund based on its price at the market close.

When investors sell shares, the same process occurs, but in reverse. Some mutual funds assess a penalty of up to 2% of the shares’ value for selling early, typically sooner than 90 days after purchase.

Mutual funds can track indexes, but most are actively managed. Actively managed funds incur high costs for analysts, economic and industry research, company visits, and administration. That typically makes mutual funds more expensive to run—and for investors to own—than ETFs.

Key Differences

ETFs

• Buying and selling can occur at any point during a trading session at market pricing.
• ETFs are not priced at the end of the day.
• There’s no minimum holding period. This is especially relevant in the case of ETFs tracking international assets, where the price hasn’t yet been updated, but the U.S. market’s valuation of it has.
• ETFs can reflect the new market reality faster than mutual funds can.
• Investors in ETFs and mutual funds are taxed based on the gains and losses incurred within the portfolios. ETFs engage in less internal trading, and less trading creates fewer taxable events.
• ETFs generally have lower expense ratios than mutual funds.

Mutual Funds

• Mutual funds can be purchased in fractional shares or fixed dollar amounts.
• Minimum initial investments for mutual funds are a base dollar amount and not based on the fund's share price.
• Investors benefit from professional managers when the fund is actively managed.

The Bottom Line

ETFs and mutual funds are baskets of individual securities like stocks or bonds. Both offer exposure to a variety of asset classes. Investors can gain more diversification from a mutual fund or ETF than investing in a single stock or bond.