On the surface, mutual funds and exchange-traded funds (ETFs) seem very similar. Both are basket-like investments that promote diversification, are professionally managed and can earn or lose money. However, they also have distinctive attributes that make them unique. Take our quiz: Which investment accounts are right for you?
What are mutual funds?
Mutual funds are pooled assets that are invested in securities such as stocks and bonds.
What are ETFs?
Exchange-traded funds (ETFs) are baskets of securities that you can buy and sell during market hours.
Similarities between ETFs and mutual funds
At first glance, you can see the many similarities between ETFs and mutual funds, including:
Pool investors' money together: Combines the money of many investors together in a basket of securities, offering portfolio diversification.
Can hold many securities: Basket-like investments that can hold hundreds or thousands of securities (stocks, bonds, commodities, currencies, etc.)
Fund types can vary: Invests in equity, fixed-income or balanced funds.
Promote diversification: Spreads your investments across various asset classes.
Charge fees: Comes with costs for administration, redemptions, purchases and possibly a shareholder fee.
Open-end funds: Always available for purchase, with an unlimited number of shares available.
Differences between ETFs and mutual funds
While mutual funds and ETFs have similarities, they also differ in many ways, including:
Mechanics: The price of mutual funds is set once every 24 hours at the end of each trading day, while ETFs are priced and traded continuously throughout the day.
Minimum investments: ETFs typically offer lower minimum investments than mutual funds.
Fund fees: Mutual funds are often more expensive than ETFs, but both come with costs in the form of expense ratios, redemptions, purchases and shareholder fees.
Taxes: ETFs are usually more tax efficient than mutual funds because they experience fewer taxable events.
This table summarizes the key differences between mutual funds and ETFs.
Questions | Mutual funds | ETFs |
|---|---|---|
When are they traded? | Bought and sold once per day | Actively traded throughout the day |
When are they priced? | Priced once per day after market close | Prices fluctuate throughout the day |
How are they managed? | Typically actively managed | Typically passively managed |
What are the tax implications? | Often have higher tax implications due to capital gains | Generally more tax-efficient due to their structure |
Mutual fund and ETF categories
You can invest in several types of mutual fund and ETF categories.
Equity funds: Invested in stocks and are considered riskier with the potential for more significant returns
Fixed-income funds: Invested in bonds and are considered to be safer and provide potentially more reliable returns
Balanced funds: Invested in a mix of stocks and bonds and may be considered more balanced in risk
Popular mutual fund and ETF subcategories
Some of the most popular subcategories include:
Global/international funds: A wide array of choices ranging from a total international fund — which includes investments from across the world — or funds composed of assets from specific areas like Asia or Europe.
Specialty funds: Allow investors to put their money in specific areas of the economy, like technology, health care, finance and real estate.
Index funds: Replicate the daily movements of the whole stock market rather than risk purchasing individual stocks.
Pros and cons of a mutual fund
Mutual funds can be diversified way to invest your money, but they come with trade-offs.
Pros of a mutual fund | Cons of a mutual fund |
|---|---|
Offers diversification | Often comes with higher expense ratios, which can cost thousands over time |
Funds are liquid, meaning you can gain access to them more easily | Brokers may charge commission and a sales charge |
Is actively managed by a professional money manager and can be a way for everyday investors to have access to professionally managed funds at a relatively lower cost | Distributions can tax you at either the ordinary income rate or capital gains rate |
Can be less risky than individual stocks and therefore might be a good investment strategy for those with long-term goals | They trade once a day, which puts a limit on when you can trade |
Pros and cons of an ETF
ETFs have grown in popularity due to their ease and diversification, but they also have some limitations.
Pros of an ETF | Cons of an ETF |
|---|---|
Offers all the benefits of mutual funds, but for lower fees and more tax efficiency | Pricing and value of ETFs are dependent on the ETF spread, which may be higher than the value of the underlying securities |
Typically offers more flexibility since they can be bought and sold much like stocks | An indexed ETF can stray from its associated index, which means that tracking errors can occur |
Choosing the right investment for you
Though mutual funds and ETFs are often confused with one another, they do have differences. Since diversification is key when it comes to investing, you might consider buying both mutual funds and ETFs to better spread out your money and work toward your financial objectives more effectively.
