Exchange-traded funds (ETFs) and mutual funds both hold a basket of stocks, bonds, currencies or commodities. Because of that, they can instantly diversify your holdings through a single investment. This can be ideal for retirement and hands-off investors who want to avoid picking stocks or other assets themselves.
| ETF | Mutual fund | |
|---|---|---|
| How ETFs and mutual funds are managed: active or passive | ETFs are typically passive funds, meaning there’s little management over their investments. They automatically track an index — like the S&P 500 or Nasdaq 100 — and the performance closely matches the index. There are actively managed funds, such as Cathie Wood’s ARK funds where they actively buy and sell stocks to try and outperform the S&P 500. | Mutual funds are known for being actively managed, even though some are passively managed, meaning they track an index as an ETF would. Actively managed mutual funds can cost slightly more to own than ETFs because they require people to make those decisions and execute them. |
| How they’re traded | ETFs are traded on exchanges. This means you can buy or sell them as you would any other stock on the market, during a trading session at the current price. This gives you greater flexibility, and you can use almost any broker or trading platform to buy ETFs. | Mutual funds are traded and priced at the end of each trading day. Typically, large and established brokerages like Vanguard and Interactive Brokers offer mutual funds, while newer trading platforms like Webull and Robinhood don’t. |
| How much they cost | ETFs often have low or no buy fees. Most brokers these days, including SoFi and Robinhood, offer $0 commission on ETF trades. What’s more, ETFs often have a lower expense ratio — i.e. an annual fee to own the fund — of less than 0.4% on average. That’s $4 each year for every $1,000 invested. However, most index ETFs, such as the S&P 500 ETF cost around 0.03% or $0.3 for every $1,000 invested. | Depending on the broker and the mutual fund, it can cost you up to $50 to buy the fund. Some brokers offer numerous mutual funds without any fees. As for the expense ratio, expect to pay slightly more for a mutual fund — between 0.5% and 1% on average. This fee is between $5 and $10 each year for every $1,000 you invest. However, S&P 500 mutual funds also have a low expense ratio, of around 0.04% or $0.4 for every $1,000 invested. |
| How much you need to invest | With ETFs, you can start investing with any amount. In the past, you had to invest enough money to buy at least one share of an ETF. But with many brokers offering fractional shares, you can buy a fraction of an ETF share for as little as $1. | Mutual funds come with specific minimums. For example, to invest in some Vanguard mutual funds, you need to invest at least $3,000. Other funds have lower requirements of at least $1,000. |
| How they’re taxed | ETFs are usually more tax-efficient than mutual funds. Basically, you won’t pay capital gains taxes unless you sell your ETF shares for a profit. If you hold ETFs in an individual account, this can have a huge impact in the long run. But it won’t make a difference with tax-advantaged accounts like IRAs or 401(k). | Mutual funds tend to incur higher capital gains taxes. That’s because they’re actively managed, meaning the asset manager often buys and sells shares. In that case, capital gains taxes could be passed on to everyone who owns shares in the fund, regardless of whether you sold your shares or not. Also, mutual funds that hold stocks and bonds can be taxed differently. |
Both assets are similar in what they offer but ETFs are more liquid, meaning you can sell them or buy them whenever you want, they are generally cheaper to buy and more tax-efficient. This makes it a better option for most investors.
The only thing going for mutual funds is that many of these funds are actively managed. To be fair, there’s also a growing number of ETFs that are actively managed, so this gap between the two types of funds is narrower these days.
Actively managed funds use a wide range of data from quantitative analysis to fundamental and technical analysis about securities and economic trends. This information allows managers to buy and sell assets to capitalize on price fluctuations and try to beat the broad market indexes.
Because these funds are actively managed, they often come with higher expense ratios, i.e. annual fees.
On the other hand, passively managed funds are those that use computer programs to trade assets. The goal is for the fund’s price to closely match the moves of a particular index, say S&P 500 or NASDAQ. Because of that, passive funds typically have the lowest expense ratios.
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Your simple and straightforward guide to ETFs, how they work and the different types available.
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