ETF vs mutual fund: what is the difference?

Written by the Tactfolio research teamPublished 6 min read

An ETF and a mutual fund both pool money from many investors to buy a basket of stocks, bonds or other assets. The main difference is how you buy and sell them. ETF shares trade on a stock exchange all day at a changing market price. Mutual fund shares are bought from and sold back to the fund once a day, at a price set after the market closes.

Key points#

  • Both are registered with the SEC and can follow an index or be run by a manager who picks investments (Investor.gov).
  • ETFs trade during market hours like a stock. Mutual funds trade once a day at the fund’s net asset value (NAV).
  • You need a brokerage account to buy an ETF. You can buy many mutual funds straight from the fund company.
  • In a regular taxable account, many ETFs pay out fewer taxable gains. Inside a 401(k) or IRA, there is no tax difference.
  • Fees depend on the fund, not the type. Low-cost index versions of both exist.

What is the difference between an ETF and a mutual fund?#

The difference is in the plumbing, not in what they hold. A Vanguard S&P 500 ETF and a Vanguard S&P 500 mutual fund own the same stocks. They just reach you in different ways.

ETFMutual fund
How you buyOn a stock exchange, through a brokerFrom the fund, or through a broker
When the price is setAll day, at the market priceOnce a day, after the close
Price you getThe market price, which can be a bit above or below the fund’s valueThe fund’s net asset value (NAV)
Minimum to startOne share, or less with fractional sharesSet by the fund, from $0 to a few thousand dollars
Automatic monthly investingDepends on the brokerUsually easy, in exact dollar amounts
Taxes in a taxable accountOften fewer capital gains payoutsCan pay out capital gains some years
Taxes in a 401(k) or IRANo differenceNo difference

The SEC lays out these differences in its investor bulletin on mutual funds and ETFs.

How are ETFs and mutual funds priced?#

A mutual fund works out the value of everything it owns at the end of each business day. That value per share is the net asset value (NAV). Any order you place during the day gets that end-of-day price. You won’t know the exact price until after the close.

An ETF also works out its NAV each day. But you buy and sell ETF shares from other investors on an exchange. The price moves all day and usually stays close to the NAV. Sometimes it drifts a little above it (a premium) or below it (a discount).

Here is an example. You place an order at 11 a.m. for a mutual fund and for an ETF that hold the same stocks. The ETF order fills right away at the 11 a.m. market price. The mutual fund order fills at the 4 p.m. NAV, even if the market moved a lot in the afternoon.

Which costs less, an ETF or a mutual fund?#

Neither type is always cheaper. The fee depends on the fund. Index funds of both types can cost a few hundredths of a percent a year. Actively managed funds of both types usually cost more.

Look at three costs:

  • Expense ratio: the yearly fee taken out of the fund. A 0.03% fee costs $3 a year for every $10,000.
  • Trading costs: most big brokers now charge no commission for ETFs, but check yours.
  • Sales charges: some mutual funds charge a fee to buy or sell, called a load. Many don’t.

For an example, see the fee table in our guide to S&P 500 index funds. The cheapest ETF and mutual fund versions there are within a few hundredths of a percent of each other.

Are ETFs better for taxes?#

In a regular taxable account, ETFs often have an edge. When a mutual fund sells holdings at a profit, it may have to pay out those gains to all its holders, and they owe tax. Many ETFs can avoid most of those payouts because of the way their shares are created and redeemed (Investor.gov).

Inside a tax-advantaged account, such as a 401(k) or an IRA, this doesn’t matter. The SEC notes there is no tax difference there. Read IRA vs 401(k) to see how those accounts work.

When does a mutual fund make more sense?#

A mutual fund can be the easier choice when:

  • Your 401(k) plan offers only mutual funds.
  • You want to invest an exact dollar amount, such as $250 every month, without fractional shares.
  • Your fund company offers a very low-cost index fund and you already hold your account there.

When does an ETF make more sense?#

An ETF can be the easier choice when:

  • You invest in a regular taxable account and want fewer taxable payouts.
  • You want to trade at a known price during the day.
  • You want a fund your broker doesn’t offer as a mutual fund, such as many sector, bond or covered call funds.

One caution: not every product with “ETF” in its name is a fund registered under the same law. Some commodity products, for example, are set up differently. The SEC suggests checking the prospectus. Read commodities explained for how commodity funds work.

Common mistakes#

  • Picking a fund type before picking what you want to own. The holdings matter more.
  • Trading ETFs often because you can. Frequent trading adds costs and taxes.
  • Ignoring loads and account fees on some mutual funds.
  • Buying an ETF at the open or close on a wild day, when prices can swing. A limit order sets the most you will pay.
  • Assuming an ETF is always cheaper. Compare the actual expense ratios.

Try it on Tactfolio#

Tactfolio strategies are built from ETFs and stocks, because their daily prices let a rule check and trade on a schedule. Every classic strategy uses ETFs, such as SPY for US stocks and TLT for long-term Treasuries. Open the 60/40 portfolio to see a simple two-ETF mix and its hypothetical backtest, or build your own mix in the strategy builder. To learn what the most common index holds, read the S&P 500 index.

Common questions#

Is an ETF safer than a mutual fund?#

No. Safety depends on what the fund owns, not its type. An ETF and a mutual fund that hold the same stocks rise and fall together. Both can lose money.

Can I hold ETFs and mutual funds in the same account?#

Yes, in most brokerage accounts and IRAs. A 401(k) only offers the funds your plan picked, which are often mutual funds.

Why do some ETFs and mutual funds have the same name?#

Some companies offer the same portfolio in both forms. Vanguard, for example, offers its S&P 500 fund as the VOO ETF and as the VFIAX mutual fund. They hold the same stocks and charge similar fees.

Do ETFs pay dividends like mutual funds?#

Yes. Both pass along the dividends and interest from what they own. You can usually take them as cash or reinvest them. Mutual funds make reinvesting simple. Many brokers can reinvest ETF dividends too.

Is an index fund an ETF or a mutual fund?#

It can be either. The words index fund describe the strategy, which is copying an index. The words ETF and mutual fund describe how the fund is bought and sold.

Sources

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