ETFs vs Mutual Funds: What Is the Difference?

Investing
Updated: 8th Feb 2021
Written by Kim Pinnelli
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Investing
February 8, 2021
Written by Kim Pinnelli

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Pooling your money with other investors in a fund you own together is a great way to diversify your investments with little work.

But you have two main options – exchange-traded funds (ETFs) and mutual funds. On the surface, they sound the same, but they have different traits and costs.

Check out our guide on ETFs vs mutual funds to see which is right for you.

ETFs vs Mutual Funds: Brief Overview

Both EFTs and mutual funds invest in a variety of assets. They diversify an investor’s money and pool the funds of hundreds of investors at a time.

But they are managed differently. ETFs are actively traded (throughout the day) and mutual funds trade only at the end of the day. Mutual funds are actively managed, and ETFs are passive.

ETFs are kicking up in popularity, mostly due to the rise of robo-advisors, but are they better than mutual funds?

Let’s dive into the details.

About Exchange-Traded Funds (ETFs)

ETFs pool investors’ money together, but they invest in funds that actively trade on the market. They’re not a stock, but they aren’t a mutual fund – they are somewhere in between.

ETFs mirror an index or try to mimic its performance. They invest in every asset on an index to get the same return as the index without investing individually in each asset. They are a passive investment – there isn’t a manager actively buying and selling assets daily.

You can buy and sell ETFs throughout the day, meaning you buy an ETF share from an investor and sell your shares to another investor.

Related: How to Start Investing

Who Are ETFs Best For?

If you want to track a market, an ETF is an easy and inexpensive way to do it. They are great for active investors who want the flexibility of buying and selling shares throughout the day.

They are also great for passive investors who want to invest and leave it and not worry about expenses.

About Mutual Funds

Mutual funds have mutual fund managers, or actual people overseeing the fund. Each fund invests in a specific asset type, such as stocks, bonds, or international companies.

When you invest in a mutual fund, you aren’t buying direct investments in the company, but an investment in the mutual fund company.

Related: Best Online Stock Brokers

Who Are Mutual Funds Best For?

Mutual funds are great for advanced investors who want to diversify their investments without the work involved in deciding the who, what, and where.

They are great for investors who won’t watch the market throughout the day and want to trade shares since mutual funds only trade at the end of the day AFTER the market closes.

Differences Between ETFs and Mutual Funds

#1. Expense Ratios

Generally, ETFs have lower expense ratios than mutual funds. On average, ETFs have a 0.03% percent expense ratio or $0.30 per $1,000 invested. Mutual funds have a higher average of 0.65 – 0.70% or $6.70 to $7.00 per $1,000 invested.

#2. How They Are Managed

ETFs are passively managed. They’re set up to track an index by investing in every asset on the chosen index. The assets aren’t bought and sold daily.

Mutual funds are actively managed. A fund manager buys and sells assets to beat the market. In exchange, they have higher fees because of the work.

#3. How They Are Traded

ETFs trade throughout the day. You can buy and sell shares like you would stocks (although you probably shouldn’t). Mutual funds trade at the end of the day and only once a day.

#4. Taxes

You only pay taxes on ETF capital gains when you sell the ETF. Mutual funds incur tax liabilities every time there is a capital gain on the asset bought and sold within the fund. This means even if you keep your shares, you still incur tax liabilities because of your portion of the capital gain.

#5. Investment Minimums

Mutual funds often require an investment of $1,000 or more. Some don’t have minimums if you commit to a monthly contribution but always read the fine print.

ETFs often have no minimum investment requirement and have a lower barrier to entry, especially for beginning investors.

Where to Invest in ETFs

Brokers typically have their own ETFs they promote heavily, but there are often other options too. Here are the best places to invest in ETFs.

#1. Robinhood

Robinhood offers free ETF trading (no commission). They don’t have a minimum investment requirement and make it easy for even beginners to understand how to invest.

Learn More: Robinhood Review

#2. Betterment

Betterment has a great selection of ETFs, both stocks and bonds, for every type of investor. They charge a 0.25 percent of assets under management fee for its basic account and 0.40 percent of assets under management for its advanced account with higher account minimum requirements.

Learn More: Betterment Review

#3. Webull

Webull also trades ETFs for $0 commission. Webull provides advanced screeners and both a mobile and desktop platform to make investing simple.

Learn More: Webull Review

Where to Invest in Mutual Funds

#1. Vanguard

Vanguard has its own mutual funds (around 150) and offers thousands of non-Vanguard mutual funds. Vanguard funds usually have no load fees but may have other fees, including fees when you buy and sell.

They offer a selection of no-load non-Vanguard mutual funds and thousands of non-Vanguard funds that do charge fees. Know what you’re investing in before choosing.

Learn More: Vanguard Review

#2. Fidelity

Fidelity has the widest selection of mutual funds with 10,000+ choices. If you buy Fidelity mutual funds, there aren’t any load fees. Some non-Fidelity funds have no fees too but watch the early redemption penalties.

Learn More: Fidelity Review

#3. E* Trade

E*TRADE has a great selection of no-load mutual funds and those with upfront fees. Most have early redemption penalties, so look at the timeline before purchasing. E*TRADE’s funds with transaction fees are $19.99 per fund, which is on the lower end.

Should I Invest in an ETF or Mutual Fund?

Choosing between an ETF and a mutual fund is a personal decision. Do you want a laid-back investment that tracks an index and typically performs well eventually or a more actively managed investment that will have ups and downs, but the excitement of greater rewards?

Learn More: Differences Between Index Funds and Mutual Funds

Is ETF Investing Safe?

Yes, ETFs are safe. They seldomly trade and only do so when the market they are following change investments. Though they are an investment, there’s always a risk of loss, but not a fraudulent loss, because they are regulated and safe.

Are Mutual Funds Safe?

Mutual funds have short-term fluctuations, but nothing different than stocks. You risk a loss like you would with any other investment. Mutual funds are safe, but always research the fund manager before investing to make sure the company is legit.

ETFs vs Mutual Funds: Which One is More Popular?

Mutual funds used to be the way to go, but today everyone leans toward ETFs. They are passively managed, the chosen investment of robo-advisors, and have a lower risk, especially for those investing long-term.

Bottom Line: ETFs vs Mutual Funds

Diversify your portfolio with ETFs and mutual funds or choose the one that feels right for you.

Watch the fees on either option and know your trading choices, including the early redemption penalties should you bail early. Either way, know what you want to invest in and find the fund that mimics your desires and beliefs.

More Investing Resources:

Kim Pinnelli
Kim Pinnelli
Kim is a personal finance expert with a Bachelor’s degree in Finance from the University of Illinois at Chicago. She has been freelance writing for 13 years for a number of large publications. Kim thoroughly enjoys helping people take charge of their personal finances.