ETFs vs. Mutual Funds: Similarities and Differences

Mutual funds and exchange-traded funds (ETFs) are two products that investors commonly choose to include in their portfolios. These investments have important similarities as well as notable differences.

Both mutual funds and ETFs, a type of exchange-traded product, are pooled investment funds registered under the Investment Company Act of 1940 that can offer investors a stake in a diversified portfolio at a relatively low cost. Investors have many mutual fund and ETF choices that can provide exposure to a wide array of assets and investment strategies, as outlined in a fund’s prospectus.

Here are some important factors to consider when investing in these products.

• Trading and Pricing – Both mutual funds and ETFs are generally considered to be liquid, meaning that they can usually be bought or sold fairly easily. However, there are key distinctions between the way these two types of products are traded and priced. 

  You can buy or sell shares in a mutual fund directly from the mutual fund company or through a brokerage firm that offers the fund. Mutual fund orders are executed once per day, and all investors who buy or sell shares in a mutual fund on a particular day receive the same price—the fund’s net asset value (NAV). The NAV, which is the per-share value of the fund’s assets minus its liabilities, is usually calculated after the major U.S. exchanges close. So if you place a mutual fund order in the morning, you’re guaranteed to get shares at NAV, but you won’t know the execution price until around 4 p.m. or later.

  In contrast, you can typically buy or sell ETF shares on an exchange—just like stocks. ETF liquidity can depend on trading activity. Large, mainstream ETFs are often actively traded and highly liquid; others that trade less frequently might be less liquid. 

  While ETFs calculate their NAV at the end of the day like mutual funds, you can trade shares at current market prices anytime during trading hours. ETF prices change throughout the day based on several factors, including trading volume and bid-ask spreads—the difference between the highest price a buyer will pay and the lowest price at which a seller will sell shares at any given time. These prices usually stay close to the ETF’s underlying value but can sometimes be higher (trading at a premium) or lower (trading at a discount). Premiums and discounts can sometimes be significant and persistent, so be sure to check where an ETF is trading relative to its NAV before you buy or sell.

• Strategies – Mutual funds have traditionally been split between passive and active management investment strategies, but more are actively managed. Historically, most ETFs tracked indexes rather than being actively managed, and most of the largest ETFs today continue to track major indexes. However, many newer ETFs are actively managed. ETFs have tended to offer more funds that provide novel or complex exposures to certain assets.
   
• Transparency/Reporting – Mutual funds are only required to disclose holdings quarterly, with up to a 60-day lag. ETFs are considered highly transparent, with holdings typically available daily. If you want to track exactly what a fund owns—especially if it employs an active strategy—you can find current ETF holdings on the issuer’s website or various financial data websites and platforms. Many brokerage firms also include this information on their website for customers.
   
• Holdings – You don’t get to choose the underlying securities or assets in either a mutual fund or an ETF. You instead rely on professional management in line with the fund’s investment strategy. However, ETFs can offer more focused or specialized exposure, such as narrow industry sectors or single asset exposure.
   
• Minimum Investments – Although some brokerage firms might offer certain mutual funds without a minimum initial investment, most mutual funds do have such a requirement, usually ranging from $500 to $3,000. By contrast, the entry price for ETFs is the cost of a share (or even a fractional share) rather than a set minimum.
   
• Fees and Expenses – Mutual funds and ETFs both charge operating expenses, usually reported as expense ratios (and expressed as a percentage of fund assets). Mutual funds may also impose sales charges and other fees, and ETF transactions might include other costs as well, such as trading commissions. Learn more about mutual fund fees and ETF fees.
   
• Taxes – ETFs generally give investors more control over their tax liability. With both mutual funds and ETFs, you decide when to sell shares—which affects when you realize capital gains for tax purposes. But with mutual funds, a tax liability can also occur when the fund manager sells holdings with embedded capital gains, even if the gains occurred before you invested. Consult a tax professional about the potential tax implications for you.
   
• Risk – Like all investment products, both mutual funds and ETFs can lose money, and how a fund performed in the past isn’t an indication of how it will perform in the future. Be sure to read a fund’s prospectus and other fund literature to familiarize yourself with its risks before investing.

Both mutual funds and ETFs can provide diversification, flexibility and exposure to a wide array of markets at a relatively low cost. Before making any investment decisions, independently research products you’re considering, and be sure you understand the differences between these two types of funds. Consider speaking with an investment professional to determine which investment products best align with your individual financial goals.