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 fundor 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.
Key Takeaways
- Mutual funds and ETFs may hold stocks, bonds, or commodities.
- Both can track indexes, but ETFs tend to be more cost-effective and liquid since they trade on exchanges like shares of stock.
- Mutual funds can offer active management and greater regulatory oversight at a higher cost and only allow transactions once daily.
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 , 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.
Note
In January 2024, the Securities and Exchange Commission(SEC) approvedthe firstspot market BitcoinETFs listed on theNYSE Arca,Cboe BZX, andNasdaqexchanges.
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.
Investors only pay capital gains taxes when they sell ETF shares. By holding on to shares, investors delay paying taxes until shares are sold.
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.
When Does a Taxable Event Occur for an ETF?
For an all-ETF portfolio, the tax will generally be an issue only if and when investors sell their shares. Just like mutual funds, if an ETF pays dividends, those count as taxable income.
When Are Investors Liable for Gains Earned From a Mutual Fund?
Unless individuals invest through 401(k) or other tax-favored vehicles, mutual funds will distribute taxable gains to investors, even if they merely hold the shares.
What Is Meant by an Open-End or Closed-End Fund?
Mutual funds and ETFs are both open-ended. The number of outstanding shares can be adjusted up or down in response to supply and demand. A closed-end fund (CEF) does not continuously offer its shares for sale but instead sells a fixed number once.
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.
FAQs
Mutual funds and ETFs may hold stocks, bonds, or commodities. Both can track indexes, but ETFs tend to be more cost-effective and liquid since they trade on exchanges like shares of stock. Mutual funds can offer active management and greater regulatory oversight at a higher cost and only allow transactions once daily.
Is it better to invest in ETFs or 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. You want niche exposure. Specific ETFs focused on particular industries or commodities can give you exposure to market niches.
What are three disadvantages to owning an ETF over a mutual fund? ›
Disadvantages of ETFs
- Trading fees. Although ETFs are generally cheaper than other lower-risk investment options (such as mutual funds) they are not free. ...
- Operating expenses. ...
- Low trading volume. ...
- Tracking errors. ...
- The possibility of less diversification. ...
- Hidden risks. ...
- Lack of liquidity. ...
- Capital gains distributions.
An index fund is a type of mutual fund that tracks a particular market index: the S&P 500, Russell 2000, or MSCI EAFE (hence the name). Because there's no original strategy, not much active management is required and so index funds have a lower cost structure than typical mutual funds.
What is more expensive ETF or mutual fund? ›
ETFs expense ratios generally are lower than mutual funds, particularly when compared to actively managed mutual funds that invest a good deal in research to find the best investments.
Which gives more return, ETF or mutual fund? ›
Mutual funds may pay capital gains distributions at the end of the year and dividends throughout the year, while ETFs may pay dividends throughout the year. But there's a difference in these payouts to investors, and ETF investors have an advantage here, too. ETFs may pay a cash dividend on a quarterly basis.
Which ETF gives the highest return? ›
6 Best Performing ETFs last 10 years in India
- Nippon India ETF Nifty 50 BeES. 102.38% 707.9%
- Nippon India ETF Gold BeES. 99.57% 467.4%
- Invesco India Gold ETF. 107.00% 288.0%
- UTI S&P BSE Sensex ETF. 95.56% 200.8%
- BHARAT 22 ETF. 161.65% 172.2%
- Nippon India ETF PSU Bank BeES.
Unlike ETFs, mutual funds can be purchased in fractional shares or fixed dollar amounts. ETFs typically have lower expense ratios than mutual funds because they offer minimal shareholder services. Though mutual funds may be slightly more costly, fund managers provide support services.
What happens if ETF shuts down? ›
Because the ETF is a separate legal entity from the issuer that manages it, the ETF will control all the assets in its portfolio up until the date set for its liquidation, at which point the manager will sell the assets and distribute the proceeds to investors.
Which is riskier ETF or mutual fund? ›
In general, ETFs can be more risky than mutual funds because they are traded on stock exchanges. Their value can fluctuate throughout the day in response to market conditions. This means that if the market takes a dip, the value of your ETF could drop quickly, and you could experience significant losses.
- Top 7 ETFs to buy now.
- Vanguard 500 ETF.
- Invesco QQQ Trust.
- Vanguard Growth ETF.
- iShares Core SP Small-Cap ETF.
- iShares Core Dividend Growth ETF.
- Vanguard Total Stock Market ETF.
- iShares Core MSCI Total International Stock ETF.
At least once a year, funds must pass on any net gains they've realized. As a fund shareholder, you could be on the hook for taxes on gains even if you haven't sold any of your shares.
How do you tell if a fund is a mutual fund or ETF? ›
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.
Are ETFs or mutual funds better for beginners? ›
The choice comes down to what you value most. If you prefer the flexibility of trading intraday and favor lower expense ratios in most instances, go with ETFs. If you worry about the impact of commissions and spreads, go with mutual funds.
Do ETFs pay dividends? ›
One of the ways that investors make money from exchange traded funds (ETFs) is through dividends that are paid to the ETF issuer and then paid on to their investors in proportion to the number of shares each holds.
What is the best mutual fund to invest in in 2024? ›
- Fidelity 500 Index Fund. : Best overall.
- Fidelity Large Cap Growth Index Fund. : Best for growth investors.
- Fidelity Investment Grade Bond Fund. ...
- Fidelity Total Bond Fund. ...
- Vanguard Wellesley Income Fund Investor Shares. ...
- Schwab Fundamental US Large Company Index Fund. ...
- Schwab S&P 500 Index Fund. ...
- Vanguard High-Yield Tax-Exempt Fund.
ETFs have several advantages for investors considering this vehicle. The 4 most prominent advantages are trading flexibility, portfolio diversification and risk management, lower costs versus like mutual funds, and potential tax benefits.
Are ETFs good for beginners? ›
The low investment threshold for most ETFs makes it easy for a beginner to implement a basic asset allocation strategy that matches their investment time horizon and risk tolerance. For example, young investors might be 100% invested in equity ETFs when they are in their 20s.
Are ETFs better for taxes than mutual funds? ›
ETFs are generally considered more tax-efficient than mutual funds, owing to the fact that they typically have fewer capital gains distributions. However, they still have tax implications you must consider, both when creating your portfolio as well as when timing the sale of an ETF you hold.
