ETFs (Exchange-Traded Funds) and mutual funds are both pooled investments that hold baskets of securities, but they trade differently. ETFs trade throughout the day like stocks, while mutual funds trade once daily after markets close. This fundamental difference affects costs, taxes, and how you invest.
For most investors, both can work well—the best choice depends on your investing style, account type, and preferences.
What Is a Mutual Fund?
A mutual fund pools money from many investors to buy stocks, bonds, or other securities. A professional manager (active funds) or algorithm (index funds) selects the holdings.
How mutual funds work:
- You buy shares directly from the fund company
- Orders execute once daily at the closing NAV (Net Asset Value)
- Minimum investments often required ($1,000-$3,000 typical)
- Dividends can automatically reinvest
Mutual funds have been the standard investment vehicle since the 1920s and remain the primary option in most 401(k) plans.
What Is an ETF?
An ETF also holds a basket of securities but trades on stock exchanges like individual stocks.
How ETFs work:
- You buy shares through a brokerage account
- Trades execute immediately at current market price
- No minimum investment—buy as little as one share
- Prices fluctuate throughout the trading day
ETFs gained popularity in the 1990s and have grown rapidly due to their flexibility and tax efficiency.
ETF vs Mutual Fund: Key Differences
| Factor | ETF | Mutual Fund |
|---|---|---|
| Trading | Throughout the day | Once daily at market close |
| Pricing | Real-time market price | End-of-day NAV |
| Minimum investment | Price of one share | Often $1,000-$3,000 |
| Expense ratios | Generally lower | Varies widely |
| Tax efficiency | More efficient | Less efficient |
| Automatic investment | Limited | Easy to set up |
| Fractional shares | Some brokers offer | Standard feature |
| Commission | Usually $0 now | Usually $0 now |
Trading and Pricing
ETF Trading
ETFs trade like stocks. You can:
- Buy or sell any time markets are open
- Use limit orders, stop orders, and other order types
- See real-time prices throughout the day
- React immediately to news or market moves
Mutual Fund Trading
Mutual funds trade once daily:
- Orders placed before 4 PM ET execute at that day’s closing NAV
- Orders after 4 PM execute at next day’s NAV
- You don’t know the exact price until after purchase
- All investors get the same price that day
For long-term index fund investing, this difference rarely matters. Whether you buy at 10 AM or 4 PM, a 20-year holding period makes that day’s price fluctuation irrelevant.
Costs and Expense Ratios
Expense Ratios
Both charge ongoing annual fees as a percentage of your investment:
| Fund Type | Typical Expense Ratio |
|---|---|
| Index ETF | 0.03% - 0.20% |
| Index Mutual Fund | 0.03% - 0.50% |
| Active ETF | 0.20% - 0.75% |
| Active Mutual Fund | 0.50% - 1.50% |
The lowest-cost index ETFs and index mutual funds now have nearly identical expense ratios. Vanguard and Fidelity offer both ETF and mutual fund versions of the same index with identical (or near-identical) fees.
Other Costs to Consider
Bid-ask spread (ETFs only): The difference between buying and selling price. For popular ETFs, this is pennies. For obscure ETFs, it can add meaningful cost.
Trading commissions: Most major brokers now offer commission-free trading for both ETFs and mutual funds.
Load fees (some mutual funds): Sales charges on some actively managed mutual funds. Avoid these—no-load funds perform just as well.
Tax Efficiency
ETFs are generally more tax-efficient than mutual funds due to their structure.
Why ETFs Are More Tax Efficient
When investors sell mutual fund shares, the fund may need to sell securities to raise cash, triggering capital gains that all shareholders must pay taxes on—even if you didn’t sell anything.
ETFs use an “in-kind” creation/redemption process that minimizes these taxable events. You typically only owe capital gains when you personally sell shares.
When Tax Efficiency Matters
Matters most:
- Taxable brokerage accounts
- High-income earners
- Actively managed funds with high turnover
Matters less:
- Tax-advantaged accounts (Roth IRA, 401(k), IRA)
- Index funds with low turnover
- Tax-loss harvesting strategies
In retirement accounts, tax efficiency is irrelevant—choose based on other factors.
Minimum Investments
ETF Minimums
Minimum = price of one share (often $50-$500)
Many brokers now offer fractional shares, letting you buy as little as $1 of any ETF. This eliminates the minimum investment barrier entirely.
Mutual Fund Minimums
Traditional minimums:
- Vanguard index funds: $3,000 (Admiral shares)
- Fidelity index funds: $0 (no minimum)
- Other fund companies: $500-$3,000 typical
Some brokers and 401(k) plans waive minimums or offer lower thresholds.
Automatic Investing
Mutual Funds Excel Here
Mutual funds make automatic investing effortless:
- Set up recurring purchases (weekly, monthly)
- Buy exact dollar amounts ($500/month, not “as many shares as $500 buys”)
- Dividends reinvest automatically
- Perfect for dollar-cost averaging
ETFs Catching Up
ETFs historically required manual purchases, but this is changing:
- Some brokers offer automatic ETF investing
- Fractional shares enable exact dollar amounts
- Dividend reinvestment now common
Check your broker’s capabilities—automatic ETF investing is increasingly available.
Which Is Better for Different Accounts?
401(k) Plans
Usually mutual funds. Most 401(k) plans only offer mutual funds. This is fine—low-cost index funds in a 401(k) are excellent regardless of structure.
IRAs (Traditional and Roth)
Either works. You control the account and can choose freely. Tax efficiency doesn’t matter in tax-advantaged accounts. Choose based on:
- Automatic investing preference (mutual funds easier)
- Available funds at your broker
- Personal preference
Taxable Brokerage Accounts
ETFs have an edge due to tax efficiency. If you’re building wealth outside retirement accounts, ETF tax advantages compound over time.
Exception: Vanguard’s mutual funds and ETFs share a structure that gives their mutual funds ETF-like tax efficiency.
HSAs (Health Savings Accounts)
Depends on your HSA provider. Many offer limited investment options. Choose the lowest-cost index fund available, regardless of structure.
ETF vs Mutual Fund: Which to Choose?
Choose ETFs If You:
- Want maximum tax efficiency in taxable accounts
- Prefer trading flexibility
- Like seeing real-time prices
- Have a broker offering automatic ETF investing
- Are investing lump sums rather than regular contributions
Choose Mutual Funds If You:
- Value easy automatic investing
- Invest through a 401(k) (often your only option)
- Make frequent small contributions
- Don’t want to think about bid-ask spreads or limit orders
- Prefer simplicity over optimization
For Most People: It Barely Matters
If you’re investing in low-cost index funds and holding long-term, the difference between an S&P 500 ETF and an S&P 500 mutual fund is minimal. Both will deliver essentially identical returns.
Don’t let the ETF vs mutual fund decision delay your investing. Pick one and start. The money you invest matters far more than the vehicle you choose.
Popular ETFs and Their Mutual Fund Equivalents
| Index | ETF (Expense Ratio) | Mutual Fund (Expense Ratio) |
|---|---|---|
| S&P 500 | VOO (0.03%) | VFIAX (0.04%) |
| Total US Stock | VTI (0.03%) | VTSAX (0.04%) |
| Total International | VXUS (0.08%) | VTIAX (0.12%) |
| Total Bond | BND (0.03%) | VBTLX (0.05%) |
Fidelity offers FXAIX (S&P 500) and FSKAX (Total Market) with 0.015% expense ratios—among the lowest available.
Combining ETFs and Mutual Funds
You don’t have to choose exclusively. Many investors use both:
- Mutual funds in 401(k) (often the only option)
- ETFs in taxable accounts (tax efficiency)
- Either in IRAs (personal preference)
The key is maintaining your target asset allocation across all accounts, regardless of which vehicle holds each asset class.
Frequently Asked Questions
Are ETFs safer than mutual funds?
Neither is inherently safer. Both can hold risky or conservative investments. Safety depends on what the fund holds, not its structure.
Do ETFs pay dividends?
Yes. ETFs pass through dividends from their holdings, just like mutual funds. You can receive cash or reinvest automatically (depending on your broker).
Can I lose money with ETFs or mutual funds?
Yes. Both are subject to market risk. If the underlying securities decline in value, your investment declines too.
Why are ETF expense ratios lower?
ETFs typically have lower operating costs—no shareholder servicing, simpler record-keeping. Competition has also driven expenses down industry-wide.
Should I switch from mutual funds to ETFs?
Not necessarily. In tax-advantaged accounts, there’s no tax cost to switching, but also limited benefit. In taxable accounts, switching triggers capital gains taxes, potentially outweighing any benefit.
What about actively managed ETFs?
They exist but remain less common than actively managed mutual funds. The same principles apply: higher fees, no guarantee of outperformance. Stick with low-cost index funds regardless of structure.
Key Takeaways
ETFs and mutual funds are more similar than different:
- Both provide diversification through pooled investing
- Both offer low-cost index options that track the same markets
- ETFs trade intraday; mutual funds trade once daily
- ETFs are more tax-efficient for taxable accounts
- Mutual funds are easier for automatic investing
- For long-term investors, the difference is minimal
- Don’t let this decision delay starting to invest
Your Next Steps
- Check what’s available in your 401(k) (usually mutual funds only)
- Decide on your asset allocation (stocks vs bonds ratio)
- For taxable accounts, compare ETF and mutual fund options at your broker
- Look for total market index funds with expense ratios under 0.10%
- Set up automatic investing if available
- Start dollar-cost averaging with whatever you choose
- Focus on your savings rate—it matters more than ETF vs mutual fund
Whether you choose ETFs, mutual funds, or both, consistent investing in low-cost index funds is the foundation of wealth building. The vehicle matters less than the habit.
Written by Maira Azhar. Fact-checked by Usman Saadat.