Mutual Funds vs. ETFs: What's the Difference?
If you've spent any time learning about investing, you've probably come across two popular investment options: mutual funds and exchange-traded funds (ETFs). Both allow investors to own a wide array of stocks, bonds or other investments through a single purchase, making it easier to build a more diversified portfolio.
Although they share many similarities, mutual funds and ETFs differ in several important ways. Understanding those differences can help you make more informed investment decisions and better understand the choices available to you in your retirement plan or investment account.
How They Trade
One of the biggest distinctions between mutual funds and ETFs is how they're bought and sold. The price of a mutual fund is determined once each business day
after the financial markets close. Any purchase or sale placed during the day is completed at that day's closing price, known as the fund’s net asset value.
ETFs, on the other hand, trade throughout the trading day on a stock exchange. Like individual stocks, their prices can fluctuate from the opening bell to the closing bell as investors buy and sell shares.
What They Cost
Both mutual funds and ETFs involve investment expenses, but the costs can vary depending on the specific fund. Index mutual funds and index ETFs track market indices such as the S&P 500 or the Russell 2000, and both typically have relatively low expense ratios, which are the yearly fees charged as a percentage of your investment.
Actively managed mutual funds and ETFs tend to carry higher expense ratios because professional managers research investments and make ongoing buy-and-sell decisions in an effort to outperform the market. And while ETFs in general often have lower expense ratios, some mutual funds can be just as inexpensive — or even less expensive — depending on the fund, making it important to compare costs rather than assume one is always the lower cost option.
How They’re Taxed
The tax treatment of these funds can be different when investing outside of a retirement account. In a taxable brokerage account, ETFs are often considered more tax-efficient because their structure generally results in fewer taxable capital gains distributions to shareholders.
By contrast, mutual funds may distribute capital gains to investors even if they haven't sold any shares, potentially creating a tax obligation. While taxes are only one factor to consider, understanding these differences can help investors make more informed decisions when investing outside a tax-advantaged retirement plan.
In Workplace Retirement Plans
Some mutual funds may also have minimum investment requirements or other fees, while many ETFs can be purchased one share at a time. It's worth noting that the differences between mutual funds and ETFs may be less noticeable in a workplace retirement plan. Many 401(k) plans primarily offer mutual funds, and participants typically invest through payroll contributions rather than purchasing shares directly. Some plans are beginning to include ETFs as investment options, but regardless of the investment type, comparing expenses and understanding your available choices can help you make more informed long-term investment decisions.
Which Is Best for Me?
Mutual funds and ETFs both offer convenient ways to invest in diversified portfolios without purchasing individual securities. While they differ in trading, costs and how they're commonly used, each can serve as an effective building block for long-term investing.
Both mutual funds and ETFs can play valuable roles in an investment portfolio. Some investors use them as the foundation of a long-term investment strategy because many of these funds provide instant diversification across dozens — or even hundreds — of individual securities. The right choice for any investor can depend on their goals, investment strategy, time horizon and personal preferences. A Financial Professional can also help you evaluate your options and determine which investments best support your long-term goals.
Sources
https://www.finra.org/investors/insights/etf-vs-mutual-fund