Financial Education Series
ETFs vs. Mutual Funds
Understanding the Key Differences
Both Exchange-Traded Funds (ETFs) and mutual funds offer investors a way to gain exposure to a diversified portfolio of securities. However, they differ in important ways that can affect costs, taxes, and how they're traded.
Understanding the Basics
Exchange-Traded Funds (ETFs)
Definition
Investment funds that trade on exchanges like individual stocks. ETFs typically track an index, sector, commodity, or other asset, but can be bought and sold throughout the trading day like a regular stock.
Key Characteristics
Common Types
Mutual Funds
Definition
Investment vehicles made up of a pool of money collected from many investors to invest in securities like stocks, bonds, and other assets. Mutual funds are priced once per day after market close.
Key Characteristics
Common Types
Key Differences
Comparing ETFs and Mutual Funds
Trading and Liquidity
ETFs: Trade like stocks throughout the trading day at market prices that may fluctuate from their underlying value. Can be bought or sold instantly during market hours.
Mutual Funds: Trade only once per day after markets close at the net asset value (NAV) price. Orders placed during the day execute at the end-of-day price.
Costs and Fees
ETFs: Typically have lower expense ratios than comparable mutual funds. While you pay brokerage commissions to trade ETFs, many brokers now offer commission-free ETF trading.
Mutual Funds: May have higher expense ratios, particularly for actively managed funds. Some may charge load fees (sales charges) and redemption fees. Look for no-load funds to avoid these charges.
Tax Efficiency
ETFs: Generally more tax-efficient because of their structure. The "in-kind creation/redemption" process minimizes capital gains distributions to shareholders.
Mutual Funds: May generate more taxable capital gains distributions when portfolio managers sell securities to meet redemptions or rebalance the portfolio.
Investment Minimums
ETFs: Can purchase as little as one share (or even fractional shares with some brokers), making them accessible to investors with limited capital.
Mutual Funds: Often require minimum initial investments ranging from $500 to $3,000 or more, though some brokers or retirement plans may waive these minimums.
Which is Right for You?
Considerations for Your Investment Strategy
ETFs Might Be Better If You:
Mutual Funds Might Be Better If You:
Final Thoughts
Both ETFs and mutual funds can be excellent investment vehicles, and many investors use both in their portfolios. Your choice should align with your investment goals, tax situation, and personal preferences regarding trading and costs. Remember that the specific fund's strategy and holdings are often more important than whether it's structured as an ETF or mutual fund.
For many long-term investors, low-cost index funds (whether ETF or mutual fund) remain one of the most effective ways to build wealth over time. Focus on keeping your overall investment costs low and maintaining a diversified portfolio aligned with your risk tolerance and time horizon.
This article is for educational purposes only and updated as of June 2024. Investment products involve risk, and past performance is not indicative of future results. For personalized investment advice, please consult with a qualified financial professional.