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ETF vs. Mutual Fund

May 11, 2023
in a nutshell
  • ETFs are baskets of securities that are bought & sold on an exchange, typically designed to match the performance of a particular index.
  • A mutual fund pools money from many investors to buy a variety of securities, such as stocks and bonds.
  • Between the two, ETFs are generally more tax-efficient and charge lower fees. Mutual funds may beat the market, so it may offer higher returns.
Image of There are pros and cons to investing in an ETF vs. mutual fund. Find out what each can do for your portfolio.
in a nutshell
  • ETFs are baskets of securities that are bought & sold on an exchange, typically designed to match the performance of a particular index.
  • A mutual fund pools money from many investors to buy a variety of securities, such as stocks and bonds.
  • Between the two, ETFs are generally more tax-efficient and charge lower fees. Mutual funds may beat the market, so it may offer higher returns.

How do you compare ETF vs. mutual fund investing? It’s a question that many new investors wonder about. While ETFs and mutual funds are similar, there are some key differences. 

Both ETFs and mutual funds are investment vehicles that offer collections of stocks, bonds and other securities. By investing in these vehicles, investors can own portions of a diverse group of assets without having to actively manage them. Let’s look at the specifics. 

What is an ETF?

ETF stands for exchange traded fund, and as the name implies, they are baskets of securities that are bought and sold on an exchange, like a stock exchange. Because ETFs trade on exchanges during regular trading hours like stocks, they are easy to buy and sell. Also like stocks, the prices of ETFs can fluctuate throughout the trading day.

ETFs share some similarities with stocks, but they represent more than one company or investment. ETFs can include collections of many stocks or other assets such as commodities. Most ETFs are index funds, meaning they track — or aim to match the performance of — a particular index, such as the S&P 500. They may also track the performance of a particular industry, sector or commodity.

Pros of ETFs

There are a number of advantages to ETFs. They usually offer diversification, allowing an investor to access a wide range of asset classes, such as domestic and international stocks, bonds and commodities. ETFs also charge lower expense ratios, which are fees to run the portfolios. And because they aren’t required to sell assets as often as mutual funds, ETFs typically realize fewer capital gains taxes and offer more tax efficiency.

ETFs also provide flexible trading. Like individual stocks, ETFs can be bought and sold on an exchange throughout the trading day. Their share prices may fluctuate throughout the day while the market is open, and investors can always know the price they can expect when they make an order to buy or sell, because those trades can be completed immediately. 

Cons of ETFs

No asset is perfect. While ETFs are generally low-cost, investors do still pay various fees for the management of the ETF.  

And because a fund manager selects the individual assets in the fund, investing in ETFs comes with less control compared to picking your own stocks. However, for investors who don’t want the responsibility of researching and selecting their own equities, the lack of control may be an advantage. 

Finally, ETFs are designed to track an index, sector, commodity or other asset; they don’t attempt to beat the market. So if you’re hoping your investment portfolio will perform better than the market in general, an ETF may not be the best investment for you. 

What is a mutual fund? 

A mutual fund is an investment vehicle that pools money from many investors to buy securities such as stocks and bonds. Through the fund, investors “mutually” purchase holdings in a variety of assets. Like an ETF, a mutual fund is often described as a basket that contains a variety of investment assets. Both mutual funds and ETFs allow investors to access a diversified investment portfolio by purchasing just one security.

Mutual funds typically charge higher fees than ETFs, and those fees sometimes include additional fees such as sales commissions. Rather than trading throughout the day while the market is open, mutual funds are bought and sold once per day, after the close of the market. Investors can place an order to buy or sell shares of mutual funds, but they may not know until the following day at what price their shares were bought or sold. 

Pros of mutual funds

Like ETFs, mutual funds offer diversification, providing access to a wider variety of investments at a lower price than they could achieve through purchasing the assets individually. And because fund managers typically trade at high volumes, they can usually reduce transaction costs for each investor. So you gain exposure to many assets without paying transaction costs you would pay to invest in all those stocks or bonds individually.

Because mutual funds are professionally managed, investing in one means you benefit from the research and expertise of a professional money manager.

Cons of mutual funds

Some mutual funds have high expenses that are passed on to investors, which reduce the return on investment (ROI). These funds may also have higher tax liabilities. When a mutual fund sells securities, it can result in year-end distributions to investors, which are taxable. Because some mutual funds aim to beat the market or a particular market index, fund managers may make many trades based on the performance of particular assets. As an investor, you have no control over the trades made by a mutual fund manager or when those trades are made. So you may end up at the end of the year with a tax bill that is higher than you expected. 

And while shares of stocks and ETFs can be bought and sold throughout the trading day, mutual funds do not offer intraday trading. They are only traded once a day, which happens after the market closes. Passive investors may not see this as a big disadvantage, but it can mean unexpected price changes. For example, let’s say you place an order at 10 a.m. to purchase shares of a mutual fund for $100 per share. But if the value of the share increases during the day, you’ll be paying a higher price than expected for your order. Similarly, if you place an order to sell shares at $100 each, but the value of the mutual fund drops throughout the trading day, you’ll end up earning less than $100 per share. 

ETF vs mutual fund: Similarities

ETFs and mutual funds are alike in some ways. For example, both types of investment vehicles offer a collection of assets, which might include stocks, bonds, commodities and real estate holdings. Individual investors can invest in both ETFs and mutual funds at an affordable price.

Also, ETFs and mutual funds both provide portfolio diversification for investors. By purchasing shares in one fund, whether mutual fund or ETF, an investor can access exposure to a diversified group of investments. 

In addition, both types of funds are professionally managed. Mutual funds traditionally have active managers who may make more trades in an effort to beat the market or a specific index. ETFs, on the other hand, often have more passive management that is geared toward simply matching the performance of their target index or sector.

ETF vs mutual fund: Differences 

Despite their similarities, ETFs and mutual funds also have some key differences. Because ETFs are exchange traded, as their name implies, they can be bought or sold during the trading day at different prices as the share price fluctuates throughout the day. With mutual funds, on the other hand, there is no intraday trading. Mutual funds can be bought and sold just once a day at a single price.

While both ETFs and mutual funds are professionally managed, most ETFs use passive management and most mutual funds are actively managed. With passive management, the ETF portfolio only changes when there are changes to the underlying index it tracks. Actively managed mutual funds, however, have managers who buy and sell securities based on active valuation methods, which allow them to make trades at their discretion.

Another difference between ETFs and mutual funds relates to taxes. Investors are required to pay capital gains taxes on earnings from both ETFs and mutual funds. But because ETFs are passively managed, they typically make fewer trades and realize lower capital gains taxes. So ETFs are generally more tax-efficient. Actively managed mutual funds usually involve more frequent trades, which often result in taxable events.

ETF vs mutual fund: Which to choose? 

ETFs and mutual funds can both be valuable parts of a diversified portfolio. If you’re trying to decide whether to choose a mutual fund or ETF, the right choice will depend on your investment strategy

Mutual funds have been around for many years. They’re a more traditional option for accessing a professionally managed, diversified collection of investments. ETFs are a newer option for doing the same thing, but they have the added opportunity to be bought and sold openly on an exchange during market hours. That means investors always know the price they will pay to purchase shares or the amount they’ll earn when they sell shares.

Investing with Acorns ETFs

Acorns offers ETF portfolios, providing diversified, tax-efficient investing without the guesswork or high fees that come with selecting your own stocks or using actively managed funds. Acorns makes it easy to save and invest through everyday purchases using Round-Ups, in which spare change from every purchase you make is invested in your ETF portfolio. 

This material has been presented for informational and educational purposes only. The views expressed in the articles above are generalized and may not be appropriate for all investors. The information contained in this article should not be construed as, and may not be used in connection with, an offer to sell, or a solicitation of an offer to buy or hold, an interest in any security or investment product. There is no guarantee that past performance will recur or result in a positive outcome. Carefully consider your financial situation, including investment objective, time horizon, risk tolerance, and fees prior to making any investment decisions. No level of diversification or asset allocation can ensure profits or guarantee against losses. Article contributors are not affiliated with Acorns Advisers, LLC. and do not provide investment advice to Acorns’ clients. Acorns is not engaged in rendering tax, legal or accounting advice. Please consult a qualified professional for this type of service.

Nancy Mann Jackson

Nancy Mann Jackson is an award-winning journalist who specializes in writing about personal finance, real estate, business and other topics. 

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