ETF vs. Mutual Fund: How the Two Popular Investment Funds Differ
ETFs trade on exchanges throughout the day like stocks, with generally lower costs and lighter tax bills; mutual funds price once a day, often carry minimums, and are the standard building block of most 401(k) plans. Here is how each works and which fits different investors.
Exchange-traded funds and mutual funds look alike on the surface: both pool money from many investors and use it to buy a basket of stocks, bonds, or both. Both exist to give an ordinary investor instant diversification without buying dozens of securities one by one. The difference is in the mechanics, and the mechanics decide when you can buy, what you pay, and what the tax bill looks like.
How an ETF works
An ETF trades on a stock exchange like an individual share of stock. Its price moves throughout the trading day, and you can buy or sell at any moment the market is open. You can also place limit orders and sell shares short, the same tools stock traders use. Most ETFs track an index, such as the S&P 500, and simply hold the stocks in that index; some are actively managed.
Two money details matter. First, ETFs often carry lower expense ratios than comparable mutual funds, because an index-tracking portfolio needs fewer people and fewer trades. Second, ETFs are usually more tax-efficient: when large investors cash out, the fund typically hands them a basket of stocks instead of selling stocks for cash, which avoids triggering capital gains that would be passed to the remaining shareholders. (Expense ratios change over time, so a fund’s current prospectus is the final word on any figure.)
The minimum to start is the price of one share, and some brokerages now sell fractional shares, so the practical minimum can be a few dollars. One cost ETFs have that mutual funds do not is the bid-ask spread, the small gap between what buyers will pay and sellers will accept, which you pay on every trade.
How a mutual fund works
A mutual fund does not trade on an exchange. You buy and sell shares through the fund company or a brokerage, and every order placed during the day executes at a single price: the net asset value calculated after the market closes at 4 p.m. ET. You cannot trade intraday, place limit orders, or sell short.
Minimums are more common. Many funds require $1,000 to $3,000 to open an account, though some waive the minimum for automatic monthly investments. Mutual funds can be actively managed, with a manager picking stocks in an attempt to beat a benchmark, and those funds usually charge higher expense ratios than index funds. Many workplace 401(k) plans are built around mutual funds, which is how many investors encounter this structure first.
The tax picture is less kind. When a fund manager sells holdings at a gain during the year, the fund must distribute those capital gains to shareholders, and shareholders owe tax on them even if they never sold a share. Fund holdings are disclosed quarterly rather than daily, so you see the portfolio with a lag.
Side by side
| ETF | Mutual fund | |
|---|---|---|
| What it is | A pooled fund whose shares trade on a stock exchange all day, with prices changing by the minute. | A pooled fund whose shares you buy and sell through the fund company or a brokerage, priced once a day after the market closes. |
| Who qualifies/gets it | Anyone with a brokerage account; the minimum is the price of one share (less with fractional shares). | Anyone with an account at the fund company or a brokerage; many funds set minimums of $1,000 to $3,000. |
| Costs | Expense ratios often lower than comparable mutual funds; you pay the bid-ask spread on each trade, and a commission at some brokerages. | Expense ratios often higher, especially for actively managed funds; no bid-ask spread; some funds charge sales loads or redemption fees. |
| Pros | Intraday trading with limit orders; usually more tax-efficient; low minimums; holdings disclosed daily for most funds. | Automatic monthly investing plans; no spreads or intraday price moves; the standard holding in most workplace 401(k) plans. |
| Cons | Prices swing during the day, which can tempt frequent trading; the bid-ask spread applies to every trade. | No intraday trading; higher expense ratios on average; a manager’s sales can hand you a taxable distribution you did not ask for. |
The verdict
Choose an ETF if you want to trade during the day, keep ongoing costs low, and avoid surprise tax bills in a taxable account. Choose a mutual fund if you are investing through a workplace plan that offers them, want set-and-forget monthly contributions, or prefer an actively managed fund with a manager you trust.
Either structure can hold the same underlying assets. An S&P 500 index mutual fund and an S&P 500 ETF track nearly the same stocks, so the choice usually comes down to your account type, the costs, and how you prefer to buy.
Explainer based on investor education materials published by the U.S. Securities and Exchange Commission and FINRA.
