Mutual funds and ETFs are similar and different in various ways. Both of them are investment vehicles that pool money from various investors to purchase a set of investments.
In this article, we explore those differences and similarities.
Mutual Fund vs. ETF – Key Takeaways
- Mutual funds are actively managed by professional fund managers and contain a pool of investments focused on a specific investment strategy.
- ETFs, on the other hand, are passive investments that track an index or asset class, such as stocks or bonds.
- Mutual funds have higher internal costs than ETFs due to the active management involved. Additionally, mutual funds can have high minimum investment requirements and impose sales charges which may be a deterrent for smaller investors.
- ETFs typically do not require any minimum investment amount and have lower expense ratios than mutual funds because of their passive structure. This makes them attractive to more cost-conscious investors who may not want to pay the premium associated with mutual fund fees.
- ETFs are better trading vehicles than mutual funds because of their better liquidity.
Mutual Funds vs. ETFs
Mutual funds are actively managed and typically involve a team of fund managers who make decisions about what stocks, bonds, or other securities to buy and sell for the fund.
ETFs, on the other hand, are passively managed portfolios that generally track an index such as the S&P 500 or the Dow Jones Industrial Average.
One major difference between mutual funds and ETFs is cost.
Mutual funds tend to have higher expense ratios than ETFs because they require more research and active management by professional fund managers.
Moreover, mutual funds often have higher minimum investment amounts which can be difficult for small investors to meet.
On the other hand, ETFs usually have much lower expense ratios and no minimum investment amounts, making them more accessible for smaller investors.
ETFs that track the S&P 500, like SPY and VOO, can have expense ratios of under 10bps (0.10%).
Mutual fund and ETF structure
The structure of mutual funds and ETFs are different.
Mutual funds are owned by shareholders who purchase shares directly from the fund itself. This means that when you buy a mutual fund share, you own an actual piece of the fund’s holdings.
ETFs, however, are traded on stock exchanges which means that when you purchase an ETF share you are trading securities on a secondary market.
This structure allows ETFs to be more liquid than mutual funds since they can be bought or sold quickly on major exchanges like NASDAQ or the New York Stock Exchange (NYSE).
Index Fund vs. Mutual Fund vs. ETF – What Are the Differences?
Let’s take a look at how index funds compare to mutual funds and ETFs.
An index fund is a type of mutual fund that invests in a portfolio of stocks or bonds that track a specific market index, such as the S&P 500 or the Dow Jones Industrial Average.
These funds are managed passively, meaning that the fund manager does not actively select investments. Instead, the fund follows the composition of the index it is tracking.
A mutual fund is a professionally managed investment fund that pools money from many investors to purchase stocks, bonds, or other securities.
Mutual funds are operated by money managers, who invest the fund’s capital and attempt to produce capital gains and income for the fund’s investors. Mutual funds have different levels of risk and return, depending on their underlying investments.
An exchange-traded fund (ETF) is a type of investment fund that is traded on a stock exchange.
ETFs are similar to mutual funds in that they are composed of a basket of assets such as stocks, bonds, commodities, or other securities.
However, as mentioned above, unlike mutual funds, ETFs typically have lower management fees and can be traded on stock exchanges at any time throughout the trading day.
ETFs also typically have greater liquidity than mutual funds, especially those with over $1 billion in assets under management.
Index Funds vs Mutual Funds vs ETFs | Which Is Best?
Mutual Fund vs. ETF Performance
This is a hard question to answer because of the multitude of products available in both categories.
Generally speaking, when comparing mutual funds to ETFs, ETFs tend to be more cost-effective and offer superior tax efficiency.
Mutual funds, on the other hand, may offer more diversification options – though the gap has been closed with the increasing popularity of ETFs. Mutual funds may offer the potential for higher returns via the active management style.
Ultimately, the performance of both mutual funds and ETFs will depend on the individual investment strategy and goals of the investor.
ETF vs. Mutual Fund Taxes
ETFs and mutual funds are both subject to taxes, but the way they are taxed can be different.
Generally, ETFs are considered to be more tax-efficient than mutual funds because they typically have lower turnover and generate fewer capital gains.
Because ETFs are traded on stock exchanges, investors can buy and sell shares throughout the day, and the greater liquidity can help with matters like tax-loss harvesting.
On the other hand, mutual funds are typically less tax-efficient because they are not traded on stock exchanges.
When investors buy or sell shares of a mutual fund, the fund manager may be required to sell securities in the fund’s portfolio to raise cash, and this can generate capital gains that are passed on to investors.
Additionally, mutual funds are required to distribute any income they receive from their investments to shareholders, and this income is subject to taxes.
The specific tax implications of an ETF or mutual fund will depend on a number of factors, including the type of securities held in the fund, the fund’s investment strategy, and the tax laws in your jurisdiction.
It’s always a good idea to talk to a tax professional before investing in an ETF or mutual fund – or making any financial choices – to understand the potential tax implications of what you’re doing.
When Were Mutual Funds and ETFs Invented?
Mutual funds are older investment products than ETFs.
The first modern mutual fund, the Massachusetts Investors Trust, was established in 1924. It was opened to outside investors in 1928, given the popularity of the rising stock market in the 1920s.
The first ETF, the Standard & Poor’s Depositary Receipts (SPDRs), known as SPY, was launched in 1993.
Are ETFs Riskier Than Mutual Funds?
It depends on the type of ETF and mutual fund.
Mutual funds can have different levels of risk, ranging from low to high, while ETFs tend to be more diversified passive products that provide a certain exposure.
ETFs can also be traded more frequently for day trading purposes, which can increase the potential for risk.
In the end, it really depends on the individual investor’s risk tolerance and investment goals.
Is It Better to Invest in the Market Through a Mutual Fund or ETF?
The answer to this question depends on your individual investment goals and risk tolerance.
Mutual funds are typically actively managed and offer a diversified portfolio of stocks and other securities.
They also often come with higher fees and may not always track the underlying index as closely as an ETF.
ETFs are typically passively managed and are generally considered more tax efficient, making them a great choice for long-term investors.
By and large, ETFs offer lower fees and more flexibility than mutual funds (e.g., they can be traded during the day).
Ultimately, it is up to you to decide which type of investment is best suited to your individual needs.
Unit Trust vs. Mutual Fund vs. ETF – What are the Differences?
A unit trust, mutual fund, and exchange-traded fund (ETF) are all types of investment vehicles.
They all involve pooling investor funds and investing the funds in a variety of securities. However, they differ in some key ways.
Unit trust (unit investment trust)
A unit trust is a type of collective investment fund – i.e., an unincorporated mutual fund – that is managed by a fund manager who makes decisions about what investments to make.
The term means different things in the UK and US.
Unit trusts in the UK are usually open-ended, meaning new shares can be issued.
In the US, unit investment trusts are closed-ended and have a fixed lifespan (proceeds are distributed back to “unitholders”).
A mutual fund is a type of collective investment vehicle that is managed by a fund manager who makes decisions about what investments to make.
Mutual funds are usually open-ended.
An ETF is a type of collective investment fund that is traded on an exchange like a stock.
ETFs are typically passive investments and track indexes such as the S&P 500. ETFs are typically available through online brokers and require no minimum investment (fractional share investing is an option with some brokers).
In summary, the main differences between unit trusts, mutual funds, and ETFs are:
- the type of investment vehicle
- the life span of the fund
- the minimum investment amount, and
- the availability of the product
Mutual Fund vs. Hedge Fund vs. ETF – What are the Differences?
Mutual funds typically offer diversification, low transaction costs, and professional management.
Mutual funds may also provide investors with access to specialized investments such as international stocks, small-cap stocks, and other asset classes that are difficult to purchase directly.
A hedge fund is a type of investment fund that pools capital from accredited investors or institutional investors and invests in a variety of assets, often with complex portfolio construction and risk-management techniques.
Hedge funds often make use of leverage, short selling, derivatives, arbitrage, complex products, private assets, and other investment strategies to maximize returns.
Hedge funds are typically only available to accredited investors or institutional investors and often require a minimum investment of $1 million or more.
However, they can be lower or (significantly) higher depending on the fund.
An exchange-traded fund (ETF) is an investment fund that holds assets such as stocks, commodities, or bonds and is traded on an exchange just like a stock.
ETFs provide investors with the ability to diversify their portfolios and gain access to a variety of asset classes, though usually little in the way of specialized investments like hedge funds might.
ETFs typically charge lower fees than mutual funds and offer greater flexibility in terms of trading options and tax efficiency.
FAQs – Mutual Fund vs. ETF
Why choose an ETF over a mutual fund?
ETFs, or exchange-traded funds, can provide investors with many advantages over mutual funds.
ETFs are typically:
- more tax efficient
- have lower costs, and
- offer more transparency than traditional mutual funds
ETFs are also traded on exchanges, which means they can be bought and sold during the day like any other stock.
Mutual funds, on the other hand, are only priced once at the end of the day.
ETFs also often have more flexibility in terms of investment strategy, allowing investors to access a variety of different asset classes and strategies in one fund.
Finally, ETFs may provide more liquidity than mutual funds, allowing investors to buy and sell quickly without affecting the price of the fund.
ETF vs. mutual fund: Which is the better investment?
It’s difficult to say which is the better investment option because it depends on your individual financial goals and risk tolerance. Like many things in finance, there’s a lot of nuance involved.
Both ETFs and mutual funds can be good options for investors, and the right choice for you will depend on your specific needs and circumstances.
ETFs are traded on stock exchanges, just like stocks.
They normally track a specific index, such as the S&P 500 or Dow Jones, and offer investors the opportunity to diversify their portfolios without having to buy individual stocks (which helps save on transaction costs and limit idiosyncratic risk).
ETFs are generally considered to be more tax-efficient than mutual funds. Moreover, they often have lower fees.
Mutual funds, on the other hand, are investment vehicles that pool together money from multiple investors and use that money to buy a diversified portfolio of stocks, bonds, or other securities.
Unlike ETFs, mutual funds are not traded on stock exchanges, and they are typically bought and sold directly through the fund company or a broker.
Mutual funds offer investors the opportunity to diversify their portfolios with a single investment (much like ETFs), and they are often managed by professional money managers.
These managers try to add value through the picks they make. In other words, they try to add alpha, which in turn may justify the higher fees.
Some investors view ETFs and mutual funds as a one-stop-shop for their investing needs because they provide diversification in a single product.
Ultimately, the choice between an ETF and a mutual fund will depend on your individual financial goals and risk tolerance.
If you are looking for a low-cost and tax-efficient way to invest in a specific market index, an ETF might be the right choice for you.
If you are looking for a professionally managed investment option, a mutual fund might be a better fit.
Conclusion – Mutual Fund vs. ETF
A mutual fund is a professionally managed investment portfolio that pools money from many investors to purchase securities.
Mutual funds typically have a portfolio manager who actively buys and sells fund holdings in accordance with the fund’s stated goal.
They are typically actively managed, meaning the portfolio manager is making decisions about what securities to buy and sell.
Mutual funds are priced once a day, usually after the market closes.
An ETF (exchange-traded fund) is an investment fund that is traded on a stock exchange, similar to stocks.
ETFs typically track an index, such as the S&P 500, or a sector or commodity and are designed to mimic the performance of the underlying benchmark.
They are passively managed. This means that the portfolio manager usually does not actively buy and sell holdings within the fund (though there are some ETFs that do).
ETFs are priced throughout the day and can be bought and sold at any time during market trading hours.