ETFs vs Mutual Funds: Which Investment is Better?
- Learn about the differences between ETFs and mutual funds
- Compare the key features of each investment
- Make the right investment choice for you
8 Min read | Invest
ETFs vs Mutual Funds: Which is the Best Investment?
You've probably heard that building a diversified investment portfolio is crucial for long-term wealth. Both ETFs and mutual funds offer you an easy way to own hundreds or even thousands of stocks without the pressure of picking individual companies.
But here's the thing: as of 2025, global ETF assets have exploded to $19.25 trillion, showing a massive shift in how Americans invest. It's closing the gap between them and mutual funds. In fact:
- 2021: Cumulative net flows (new money invested) into ETFs since their launch first surpassed those of mutual funds.
- 2024: Passive mutual funds and ETFs combined captured 51% of total AUM, with the ETF component (29%) surpassing the mutual fund component (22%) within the passive category.
- 2038: The growth rate of ETFs is significantly higher than that of mutual funds, with ETFs seeing consistent and record-breaking annual inflows. This has led to forecasts by firms like Cerulli Associates that US ETF AUM may overtake mutual funds by 2038.
This guide breaks down ETFs vs mutual funds across costs, taxes, trading flexibility, and performance. You'll learn which option fits your specific goals, whether you're investing a set amount each month, actively managing your portfolio, or building long-term wealth. By the end, you'll know exactly which investment type delivers better after-tax returns for your situation.
Understanding ETFs and Mutual Funds: The Basics
What is an ETF?
An exchange-traded fund (ETF) is an investment fund that trades on stock exchanges throughout the day, just like individual stocks. When you buy an ETF, you're purchasing a basket of securities that might include hundreds or thousands of stocks, bonds, or commodities.
Most ETFs track indexes like the S&P 500, meaning they automatically own all 500 companies in that index. You can buy ETFs through any brokerage account, often with no minimum investment beyond the current share price. If an ETF costs $87 per share, that's all you need to get started.
ETFs are regulated by the SEC under the Investment Company Act of 1940, providing strong investor protections. They come in both passive varieties (tracking indexes) and active varieties (where managers pick specific investments).
You'll find ETFs covering nearly every investment strategy imaginable. Want exposure to technology stocks? There's an ETF. Interested in corporate bonds? There's an ETF. Even niche strategies like uranium mining or solar energy have dedicated ETFs.
What is a Mutual Fund?
A mutual fund is also a pooled investment vehicle that holds diversified securities. The key difference: mutual funds trade only once daily after the market closes at the net asset value (NAV).
You purchase mutual funds directly from fund companies like Vanguard or Fidelity, or through brokers. Most mutual funds require minimum initial investments, typically $500 to $3,000. Vanguard's index funds, for example, require $3,000 to start.
Like ETFs, mutual funds are SEC-regulated under the Investment Company Act of 1940, giving you similar investor protections. They also come in passive (index-tracking) and active (manager-selected) varieties.
Mutual funds have been around since 1924, making them the traditional choice for American investors. They offer professional management and instant diversification, which is why they remain popular in 401(k) plans and retirement accounts.
ETFs vs Mutual Funds: Head-to-Head Comparison
Here is a table with a comparison overview at a glance.
| Feature | ETFs | Mutual Funds |
|---|---|---|
| Trading | Intraday on exchanges like stocks | Once daily at NAV after market close |
| Minimum Investment | One share price (often $1-$100, fractional available) | Typically $500-$3,000 initial |
| Expense Ratio (Index) | 0.40% average | 0.60% average |
| Expense Ratio (Active) | 0.69% average | 0.89% average |
| Sales Loads | None | Often 1-2% front or back-end |
| 12b-1 Fees | Typically none | Up to 1% annually |
| Bid-Ask Spread | Yes ($0.01-$0.05 for liquid ETFs) | None |
| Tax Efficiency (Capital Gains) | 0.1% annual distributions | 1.76% (index) to 3.44% (active) |
| Holdings Transparency | Daily, before market open | Quarterly, 60-day delay |
| Fractional Shares | Limited availability, growing | Always available after initial minimum |
| Automatic Reinvestment | May require manual setup | Typically automatic |
| Best For | Active traders, taxable accounts, buy-and-hold investors | Dollar-cost averaging, automatic investing, tax-deferred accounts |
Trading Flexibility and Timing
ETFs
ETFs trade throughout the day like stocks with real-time pricing. You can place limit orders, stop-loss orders, and even use options strategies. If the market drops at 11:00 AM and you want to buy immediately, you can.
Mutual Funds
Mutual funds trade once daily after the 4:00 PM market close at the NAV. You submit your order anytime during the day, but you won't know your exact purchase price until after the market closes.
- Winner: ETFs for active traders who want control over timing and price. Mutual funds win for investors who prefer predictable end-of-day pricing without worrying about intraday volatility.
Check out these links for detailed advice on how to buy ETFs and Mutual Funds.
Cost and Expense Ratios
The most important cost that you will need to pay when trading both ETFs and mutual funds is the expense ratio. This tells you what percentage of your investment goes to fund management annually. It is deducted automatically on a daily basis, not all at once each year.
Every trading day, a small portion of the fund's expenses gets subtracted from the net asset value (NAV) before the closing price is calculated. This happens behind the scenes, so you won't see it on your brokerage statement. There's no line item saying "expense ratio deducted." The cost simply chips away at your returns gradually and invisibly over time.
Here's a table where you can compare the average expense ratio of ETFs vs mutual funds.
| Investment Type | ETF Average Expense Ratio | Mutual Fund Average Expense Ratio | Annual Cost Difference (on $10,000) |
|---|---|---|---|
| Index/Passive Funds | 0.16% | 0.36% | $20 |
| Actively Managed Funds | 0.68% | 1.02% | $34 |
| Bond Funds | 0.14% | 0.48% | $34 |
| Sector/Specialty Funds | 0.47% | 0.98% | $51 |
Why is expense ratio important? Because it directly affects your portfolio returns. For instance, on a $10,000 investment over 20 years, a 0.20% difference in expense ratios costs you roughly $1,000 in lost returns.
Now, apart from the expense ratio, there are other costs that you need to consider:
ETFs
ETFs have bid-ask spreads, typically $0.01-$0.05 for liquid ETFs.
Mutual Funds
Mutual funds often charge sales loads instead (1-2% upfront or when you sell) and marketing fees (up to 1% annually).
- Winner: ETFs deliver lower costs across both index and active strategies, saving you significant money over time.
Tax Efficiency
ETFs
This is where ETFs truly shine. ETFs distributed only 0.1% of their value in capital gains in 2023.
The magic happens through the in-kind creation-redemption mechanism. When investors sell ETF shares, authorized participants exchange them for underlying securities instead of cash, avoiding taxable events.
Mutual Funds
In the same study by Morning Star, index mutual funds distributed 1.76% of their value in capital gains and 3.44% for active mutual funds.
Here's a shocking example: in 2022, when the S&P 500 fell 18.1%, over 42% of active mutual funds still distributed capital gains averaging 5% of NAV. Investors paid taxes on gains while their fund values dropped.
- Winner: ETFs dominate for taxable accounts. This advantage alone can boost your after-tax returns by 0.5-1.0% annually.
Minimum Investment Requirements
ETFs
ETFs require only the cost of one share, often under $100. Many brokers now offer fractional shares for as little as $1, making ETFs accessible to anyone. Wondering how many shares you should buy? Check out our article here.
Mutual Funds
Mutual funds typically require $500-$3,000 initially. Vanguard requires $3,000 for most index funds, though some fund families offer lower minimums. After your initial investment, you can invest any dollar amount.
- Winner: Tie. ETFs win for initial accessibility. Mutual funds win for ongoing fractional dollar investments without leaving cash uninvested.
Transparency and Holdings Disclosure
ETFs
ETFs disclose full holdings daily before the market opens, as required by SEC Rule 6c-11. You always know exactly what you own.
Mutual Funds
Mutual funds disclose holdings quarterly with a 60-day delay. You might be looking at portfolio data that's three months old.
- Winner: ETFs provide real-time portfolio visibility, letting you make informed decisions based on current holdings.
Liquidity
ETFs
ETFs have two-layer liquidity: exchange trading plus the authorized participant creation-redemption mechanism. Even during the March 2020 COVID crisis, ETF liquidity remained resilient.
Mutual Funds
Mutual funds depend solely on the fund manager buying and selling securities. During market stress, large redemptions can force managers to sell holdings at unfavorable prices, hurting remaining shareholders.
- Winner: ETFs maintained superior liquidity even during extreme market volatility, protecting investor interests.
Standout Features: What Makes Each Investment Unique
Unique ETF Advantages
In-Kind Creation-Redemption Process: Authorized participants exchange baskets of securities for ETF shares in 25,000-50,000 share creation units. This mechanism keeps the market price aligned with NAV through arbitrage and enables tax-efficient portfolio management by transferring out the lowest-cost-basis shares, avoiding taxable events.
Intraday Trading Strategies: You can use limit orders to buy at your target price, stop-loss orders to protect against declines, options strategies for income or hedging, and even short selling for tactical adjustments. These strategies are completely unavailable with mutual funds.
Real-Time Price Discovery: ETFs provide continuous pricing with intraday NAV (iNAV) updating every 15 seconds. During volatile markets, you know exactly what you're paying and can act on opportunities immediately.
No Sales Loads or Fees: You never pay the 1-2% sales charges or ongoing marketing fees that many mutual funds impose. Your entire investment goes to work immediately.
Active ETF Innovation: Active ETFs attracted $523.51 billion in inflows year-to-date through October 2024, showing that professional management can now access the tax-efficient ETF structure while maintaining competitive strategies.
Unique Mutual Fund Advantages
True Fractional Share Investing: You can invest exact dollar amounts like $237.50 without leaving cash uninvested. If you want to invest $500 monthly regardless of share price, mutual funds let you buy 15.384 shares at $32.50 each, while ETFs require buying 15 whole shares for $487.50, leaving $12.50 sitting idle.
No Bid-Ask Spread: All investors receive identical NAV pricing regardless of when they submit orders. You eliminate transaction cost uncertainty and always know you're getting fair pricing.
Automatic Features: Mutual funds offer automatic dividend reinvestment, automatic rebalancing in target-date funds, and systematic investment plans built into the fund infrastructure. Set it once and forget it.
Simplified Tax Reporting: You receive a single 1099-DIV form covering all transactions, making tax filing straightforward. Frequent ETF traders might receive multiple forms from different transactions.
No Premium/Discount Volatility: Mutual funds always trade at exact NAV, eliminating the temporary price deviations that can occur with international or thinly-traded ETFs. You never pay more than fair value.
ETFs vs Mutual Funds: FAQs
What is the main difference between an ETF and a mutual fund?
ETFs trade throughout the day on stock exchanges like individual stocks, while mutual funds trade once daily after market close at the net asset value. ETFs use an in-kind creation-redemption mechanism with authorized participants, while mutual funds buy and sell securities directly with cash.
Are ETFs more tax-efficient than mutual funds?
Yes, ETFs are significantly more tax-efficient. ETFs distributed only 0.1% in capital gains in 2023, compared to 1.76% for index mutual funds and 3.44% for active mutual funds. The in-kind redemption process allows ETFs to avoid most taxable events that mutual funds can't escape.
Which is better for beginners: ETFs or mutual funds?
For automatic investing and dollar-cost averaging with fixed monthly amounts, no-load index mutual funds often work better because you can invest every penny. For buy-and-hold investors in taxable accounts who want the lowest costs and best tax efficiency, ETFs deliver better after-tax returns over time.
Can you lose money in ETFs and mutual funds?
Yes, both ETFs and mutual funds carry market risk and can decline in value when the underlying securities fall. However, diversification across hundreds or thousands of securities reduces the risk of any single company's failure destroying your investment.
Do ETFs have lower fees than mutual funds?
Yes, index ETFs average 0.40% expense ratios versus 0.60% for index mutual funds, and active ETFs average 0.69% versus 0.89% for active mutual funds. Mutual funds also often charge 1-2% sales loads and up to 1% in 12b-1 marketing fees that ETFs don't have.
Which is better for a 401(k) or IRA: ETFs or mutual funds?
In tax-deferred accounts like 401(k)s and IRAs, the tax efficiency advantage of ETFs disappears because you don't pay taxes until withdrawal anyway. Your choice depends on available options, costs, and whether automatic investing features matter to you. Many 401(k) plans only offer mutual funds.
Are mutual funds safer than ETFs?
Both carry similar market risk and SEC regulation under the Investment Company Act of 1940. Mutual funds eliminate intraday price volatility and premium/discount deviations, which some investors find less stressful, but this doesn't make them fundamentally safer investments.
Can I buy ETFs and mutual funds in the same portfolio?
Yes, many investors use both strategically. You might hold mutual funds in your 401(k) plan where employer offerings are limited and automatic payroll deductions make sense, while holding ETFs in your taxable brokerage account where tax efficiency delivers the most value.
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The Bottom Line: Choosing Between ETFs and Mutual Funds
ETFs win for most people. They're cheaper, more tax-efficient, and more flexible. Mutual funds still make sense if you want automatic monthly investing or prefer keeping things simple.
The smart move? Use both. Mutual funds in retirement accounts, and ETFs in taxable accounts.
But honestly, your choice between ETFs and mutual funds matters way less than actually investing consistently, staying diversified, and keeping costs low. Pick one and get started - that's what really counts.
If you fancy some extra reading and our best advice, check out our article on the Best ETFs to Buy Now.
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