ETFs vs. Mutual Funds: What's the Difference?

Exchange-traded funds (ETFs) and mutual funds solve the same problem: they let you own a diversified basket of stocks or bonds with a single purchase. Many ETFs and mutual funds even track the exact same index. The differences are in how you buy them, what they cost and how they are taxed.

How they trade

ETFs trade on a stock exchange just like individual shares. Their price changes throughout the day, and you can buy or sell any time the market is open, using the same order types you would use for a stock.

Mutual funds are bought and sold directly through the fund company or your broker, and every order is filled once a day at the fund's net asset value (NAV), calculated after the market closes. You won't know the exact price until the end of the day.

Costs

Both charge an annual expense ratio, a percentage of your investment taken out of the fund each year. Index ETFs and index mutual funds are usually very cheap; actively managed funds of either type usually cost more. Some mutual funds also charge sales loads or other fees, so read the fund's fee table before buying. Most large brokers now let you trade ETFs commission-free.

Minimums and automation

Some mutual funds require a minimum first investment, sometimes $1,000 or more, though many brokers have lowered or dropped these. ETFs historically required buying whole shares, but many brokers now offer fractional shares. Mutual funds have one practical advantage: they make it easy to invest an exact dollar amount automatically every month, which suits dollar-cost averaging.

Taxes

In a regular taxable account, ETFs are usually more tax-efficient. Because of the way ETF shares are created and redeemed, they rarely need to sell holdings and pass on capital gains to investors. Mutual funds more often distribute capital gains at year-end, which can create a tax bill even if you didn't sell anything. Inside a tax-advantaged account like an IRA or 401(k), this difference doesn't matter. See Roth vs. traditional IRA for more on those accounts.

Quick comparison

• Trading: ETFs trade all day; mutual funds once a day at NAV.
• Fees: both can be very low for index funds; check the expense ratio.
• Minimums: ETFs, the price of one share or less; mutual funds, sometimes a set minimum.
• Automatic investing: easier with mutual funds, though many brokers now automate ETF purchases too.
• Taxes in a taxable account: ETFs usually win.

Which should you choose?

For most long-term investors, what the fund holds and what it costs matter far more than whether it is an ETF or a mutual fund. A low-cost fund tracking a broad index like the S&P 500 or the total US market is a common core for a portfolio. Pick the type your broker makes easiest and cheapest, and keep contributing regularly. Our broker comparison shows which brokers offer commission-free ETFs and fractional shares.

This article is educational and not investment advice.