Key takeaways
- Both pool many investors' money into a professionally managed portfolio, and both register with the SEC.
- Mutual fund shares are bought from and sold back to the fund at the net asset value calculated after the close; ETF shares trade on an exchange at market prices during the day.
- An ETF's market price can sit above or below its net asset value, a premium or discount, and buying or selling one involves a bid–ask spread.
- In taxable accounts, many ETFs distribute fewer capital gains because of in-kind exchanges; in tax-advantaged accounts there is no tax difference.
- Both charge fees that are paid whether or not the fund does well, so compare expense ratios, loads and trading costs.
Mutual funds and exchange-traded funds (ETFs) solve the same problem: they let many investors pool their money into one professionally managed portfolio, so each person owns a slice of a diversified basket rather than a handful of individual stocks. Where they differ is in the plumbing: how shares are bought and sold, how they are priced, what they cost and how they are taxed. The SEC's investor bulletin on the characteristics of mutual funds and ETFs lays the differences out clearly, and this guide follows it.
What they have in common
- Both are registered. Both are investment companies that file registration statements with the SEC, and each provides a prospectus, free from the fund or from the SEC's EDGAR database.
- Both pool money. Each share represents a proportionate ownership of the fund's portfolio, with its gains and losses.
- Both are usually professionally managed by SEC-registered investment advisers.
- Both can be passive or active. A passive fund tries to match an index; an active one relies on a manager's choices. Passive funds are usually called index funds, whichever wrapper they use.
- Both can diversify, though the SEC cautions that some funds are much less diverse than others, and some ETFs even track a single stock.
The SEC also notes you cannot always tell from a name whether something is a mutual fund, an ETF or another kind of product; check the prospectus.
The key differences
| Mutual fund | ETF | |
|---|---|---|
| Where you buy and sell | From and back to the fund (directly or through an intermediary) | On a stock exchange, through a broker |
| Price you get | Net asset value (NAV) per share, typically calculated at the end of each business day, plus or minus fees | Market price during the trading day, plus or minus fees |
| Price vs NAV | Always NAV | Can trade at a premium or discount to NAV |
| Account needed | Can be held directly with the fund | A brokerage account |
| Typical charges | Expense ratio; some funds add sales loads and 12b-1 fees | Expense ratio; commissions and the bid–ask spread when trading |
| Capital gains distributions in taxable accounts | Generally taxable when paid | Typically fewer, because of in-kind exchanges |
Pricing and trading
A mutual fund calculates its net asset value, the value of its holdings minus liabilities, per share, typically once at the end of each business day. Orders placed during the day are filled at that next calculated NAV. An ETF must also calculate NAV every business day, but you trade it like a stock, at whatever the market price is when your order executes. The SEC notes that an ETF's market price generally stays close to its end-of-day NAV but may vary significantly, and that the price moves through the day.
Trading on an exchange also means the ETF trades have a bid–ask spread, and that order types such as limits apply.
Fees and expenses
The SEC stresses that investors in both types of fund pay fees and expenses regardless of how the fund performs. The main ones:
- Expense ratio. Annual operating expenses as a percentage of average net assets, paid out of fund assets, which reduces the value of every share.
- Sales loads. Mainly a mutual fund charge to compensate brokers. The SEC's example: a $10,000 purchase with a 5% front-end load pays $500 to the selling broker, leaving $9,500 to invest.
- 12b-1 fees. Distribution and service fees, typically charged by mutual funds and not ETFs.
- Trading costs. For ETFs, any commission and the spread when you buy or sell.
The SEC also warns that "zero-expense" claims can hide other costs paid separately. Small differences matter over time. As a purely hypothetical illustration, not a forecast: if a portfolio earned 6% a year before costs, $10,000 compounding for 20 years after a 0.10% annual expense ratio would grow to about $31,500, against about $26,500 after a 1.00% ratio, a gap of roughly $4,900.
Taxes
In a taxable account, both kinds of fund may pass capital gains distributions to investors, which are taxable even if you did not sell. The SEC explains that many ETFs buy and sell portfolio securities through in-kind exchanges rather than for cash, so they typically have fewer capital gains distributions. In a tax-advantaged account such as a 401(k) or IRA, the SEC notes there is no tax difference between the two. The US rules for gains you realise yourself are in capital gains on stocks.
Choosing between them
Mutual fund or ETF is only one of the choices; the strategy, holdings and costs of the specific fund matter too. The SEC's bulletin suggests reading the prospectus for the investment strategy, risks, fees and how shares are bought and sold. Diversification explained covers what a fund can and cannot do for risk.
To practise market and limit orders before trading anything on an exchange, Learn to Trade Stocks Beginner offers simulated trades with a virtual balance. It is one of our education apps, and the investing basics hub lists the related guides, including what a brokerage account is.
Good to know
Frequently asked questions
What is the main difference between an ETF and a mutual fund?
Are ETFs cheaper than mutual funds?
Are ETFs more tax-efficient?
Do I need a brokerage account for an ETF?
Sources
- Characteristics of Mutual Funds and Exchange-Traded Funds (ETFs) – Investor Bulletin (opens in a new tab)Investor.gov, U.S. Securities and Exchange Commission — accessed
- Mutual Fund and ETF Fees and Expenses – Investor Bulletin (opens in a new tab)Investor.gov, U.S. Securities and Exchange Commission — accessed
- Exchange-Traded Fund (ETF) (glossary) (opens in a new tab)Investor.gov, U.S. Securities and Exchange Commission — accessed
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