Skip to main content

Mutual Funds vs. ETFs: Differences and Benefits Explained

6 minute read

Devon Taylor

By Devon Taylor

Reviewed by Riley Adams, CPA

Two of the most popular investment vehicles are mutual funds and exchange traded funds. For many people though, these two investments tend to blur together. There is a lot of confusion among amateur investors between the two. How are they the same? How are they different? Does one have more benefit than the other? Most important, which one is right for you?

Lucky for you, we will attempt to clear up the confusion in this article. We will clearly explain the ins and outs of mutual funds and ETFs, including their differences and benefits. By the end of this article, you should feel a lot more comfortable knowing exactly how your money is being invested.

Mutual Funds and ETFs – Similarities

Mutual funds and ETFs are known as “passive investment vehicles.” That’s because they each try to track or replicate benchmark stock indexes such as the S&P 500. Some might track stocks in a specific economic sector instead, like technology, mining, or energy. In most cases, investors do not have to actively manage a mutual fund or ETF.

Most mutual funds are managed by a professional at a bank or investment firm. Mutual funds and ETFs are also known as “pooled investments.” As that label implies, they take money from many different investors (usually hundreds or thousands of people) and pool it together. Pooled investment funds offer diversification and economies of scale.

Mutual funds and ETFs can invest their pooled money in thousands of individual stocks. Both investments are regulated by the exact same securities laws. For these reasons, it’s understandable that many people wrongly assume that mutual funds and ETFs are basically the same. While they each take a similar approach to investing, the reality is that there are distinct differences between the two. Which investment type is best for you will depend on your individual circumstances and appetite for risk.

Benefits of Mutual Funds

The first mutual fund in the United States was offered in 1924 during the bull run that preceded the Great Depression. Since then, mutual funds have provided investors with a massive selection of pooled fund options. While some mutual funds are passively managed, the vast majority are actively managed by a professional manager. Their full time job is to build a profitable portfolio for their clients. They carefully pick various stocks to invest in. It’s not as easy as simply tracking or replicating a stock index like the NASDAQ.

Mutual funds are great if you don’t feel confident managing your own investments. If you have little knowledge or experience with picking stocks by yourself, a mutual fund is a good choice. Let a professional do it for you. Not only that, but your money will work in partnership with the investment of others. You might not be able to afford 100 shares of Tesla on your own, for example. But your mutual fund certainly can.

Downside of Mutual Funds

Mutual funds tend to be more complex than ETFs. They are also more expensive. Mutual funds have management fees that are typically much higher than the fees associated with ETFs. The mutual fund fees, usually called the “Management Expense Ratio” (MER), are to pay the fund manager and their institution. Basically, it’s the service fee you pay to have an expert manage your investments on your behalf.

Mutual funds are also structured in multiple share classes. Each share class has its own fee that might require you to pay different types of sales loads to a broker. There can also be operational fees charged with mutual funds. All of the various fees are rolled together and expressed as the MER. It’s typically charged as a percentage of the return or profit on the mutual fund. That means the better your investments do, the more it costs you. The fees do not typically come out of the principal amount invested.

Another important difference to note is that mutual funds are priced based on a Net Asset Value (NAV) that is calculated at the end of each trading day. Standard mutual funds can only be bought and sold at their NAV price. That means that investors placing a trade during the trading day must wait until the final price is calculated for the trade to actually be executed.

ETF Explained

Exchange traded funds are a much newer investment product than mutual funds. The first ETF was created in the mid-1970s by investor John Bogle, who founded and was CEO of The Vanguard Group. That company remains one of the largest issuers of ETFs in the world today. The first widely available ETF was introduced in 1993 to track the S&P 500 Index. At the start of 2018, there were more than 3,400 ETFs available to investors. By 2019, more money flowed into ETFs than mutual funds for the very first time. That signaled a shift in popularity towards ETFs among investors.

ETFs are the most passive investment you can own. By that, we mean they are not managed by an individual investor or a professional manager. An ETF simply replicates the stocks of a particular index, such as the S&P 500. As the stock index goes, so goes the ETF. If the stock index rises, the ETF rises. If the index declines in value, the ETF declines as well. Where a mutual fund manager tries to beat the performance of a benchmark index, an ETF simply tries to match the performance.

Benefits of ETFs

The main benefits of ETFs are that they offer exposure to markets and diversification at a fraction of the cost of a more actively managed mutual fund. They don’t carry sales load fees either. You will pay a commission (if required) for trading an ETF, but it’s also possible to avoid that. Many ETFs trade for free through online or electronic brokers.
When it comes to operational expenses, ETFs also tend to be cheaper. They offer lower management fees since they are passive funds. In short, you’re not paying someone to analyze an ETF on a daily basis to ensure maximum return. Transaction fees are also typically lower, since less trading is needed.

The pricing of ETFs is often much different than mutual funds. ETFs trade throughout the day just like a stock. This active trading can appeal to many investors, who prefer real-time trading and transaction activity. Investors do not have to wait until the end of the trading day to execute a transaction with an ETF, unlike a mutual fund.

Performance/Return On Investment

Over the long-term, very few fund managers beat the stock market. For this reason, it may be more advantageous to invest in an ETF than a mutual fund. Consider that the S&P 500, comprised of the 500 largest U.S. companies, has provided an average annualized return of 9.96% since 1990.

By comparison, most mutual funds advertise annual returns of between 2.5% and 5%. When it comes to long-term performance and return on investment, it’s hard to beat an ETF. Given the unpredictable nature of stocks and the ups and downs of the stock market, it’s very difficult for even skilled mutual fund managers to post better returns than you could get from using your money to track the markets directly.

Tax Implications

When it comes to taxes, mutual funds and ETFs are largely treated the same by the government. Unless either investment vehicle is held in a tax sheltered or tax deferred account such as a 401(k) or RRSP, then you’ll be taxed on any capital gains and dividends you receive. Investments in a 401(k), IRA, or RRSP can grow tax-free and do not incur taxes when trades are made.

That said, mutual funds tend to have higher tax implications. This is simply because they pay their investors capital gains distributions. These capital distributions are taxable regardless of whether they are held in a tax deferred account or not. ETFs usually do not pay out capital distributions. Therefore, they have a slight tax advantage over mutual funds.

The Bottom Line

When you considers the costs, performance, and tax implications of both products, ETFs appear to be the better choice. However, mutual funds may still appeal if you want your money managed by a professional. If you don’t want to be bothered with tracking the performance of the stock market yourself, then a mutual fund may make sense. Just read the quarterly statement they send you and ensure your money is growing to your satisfaction.
However, if you’re focused on maximizing your returns, keeping fees low, and paying less tax, then ETFs are the clear choice as an investment vehicle.

Charts Analyzed on TabletShutterstock
Riley Adams

Financial Expert

Riley is a San Francisco-based senior financial analyst and CPA at Google who also runs the personal finance site, Young and the Invested. He and his wife have one child together and all three enjoy exploring the outdoors of Northern California. Previously, he worked for a public utility in New Orleans for six years after graduating from Penn State University with his M.S. in Applied Economics and Demography.


The Top Online Stock Trading Tools and Resources for Serious Investors Investing

The Top Online Stock Trading Tools and Resources for Serious Investors

In the dynamic, fast-paced world of stock trading, having access to the right tools and resources can play a decisive role in determining the outcome of your investment journey. The difference between success and setbacks often hinges on the tools you have at your disposal. Given the sheer volume and variety of options available, it’s […]

Read More about The Top Online Stock Trading Tools and Resources for Serious Investors

3 minute read

Required Minimum Distribution: Everything You Need To Know Investing

Required Minimum Distribution: Everything You Need To Know

After decades of productivity and setting aside a portion of your paycheck, you eventually hit retirement age. Now you need to plan how you will make withdrawals from your savings to meet your living expenses in retirement. The IRS requires retirement account holders to start taking mandatory withdrawals from their qualified retirement accounts once they […]

Read More about Required Minimum Distribution: Everything You Need To Know

6 minute read

What is Socially Responsible Investing (and Should You Do It)? Investing

What is Socially Responsible Investing (and Should You Do It)?

There’s one very specific thing I remember about my dad’s views on investing. He told me multiple times that he simply wouldn’t touch certain investments, out of principle alone. For starters, he refused to ever short a stock. That’s because shorting a stock is basically betting on someone else to fail, meaning you profit off […]

Read More about What is Socially Responsible Investing (and Should You Do It)?

8 minute read

What Is Stablecoin? (And Should You Invest In It?) Investing

What Is Stablecoin? (And Should You Invest In It?)

In the year 2021, the price of Bitcoin has gone up and down by tens of thousands of dollars. This type of volatility can be attractive to those looking to make a quick buck by buying the dip. However, for many conservative investors, this behavior has made getting into cryptocurrency a non-starter. If you fall […]

Read More about What Is Stablecoin? (And Should You Invest In It?)

7 minute read

Moves To Make If You’re Worried About a Stock Market Crash stock market crash Investing

Moves To Make If You’re Worried About a Stock Market Crash

We wouldn’t blame you for being worried about a potential stock market crash right now. The Delta variant of COVID-19 is currently ripping through the United States (and other parts of the world). Chinese real estate behemoth Evergrande is tanking, threatening to take portfolios around the world with it. Then there’s the issue of the […]

Read More about Moves To Make If You’re Worried About a Stock Market Crash

6 minute read

See all in Investing