Both can hold a broad basket of investments. An ETF trades on an exchange during the day like a stock. A mutual fund is usually bought from the fund or a provider and gets one price after the market closes.
The differences that matter
The wrapper is different, but the investments inside can be nearly the same. One broad U.S. stock ETF and one broad U.S. stock mutual fund may own many of the same companies.
ETF prices move during the trading day. You may pay a little more than the value of what the ETF owns, or receive a little less when selling. Mutual fund orders use the next calculated net asset value, so you do not know the exact price when you place the order during the day.
Costs depend on the exact fund and account. Compare the expense ratio, sales charges, trading costs, account fees, and tax effects. In a tax-advantaged account such as a 401(k) or individual retirement account, the SEC notes that the ETF-versus-mutual-fund tax difference does not apply in the same way.
Two reasonable choices
Priya wants to invest $200 from every paycheck. Her provider lets her buy a mutual fund in exact dollar amounts with no sales load. That makes automatic investing simple.
Sam wants to trade during the day and the broker supports fractional ETF shares. An ETF works well for Sam. Neither label makes one choice better by itself; the right answer depends on the fund, the account, and how the person invests.
What a quick comparison can miss
Do not compare one expensive active mutual fund with one cheap index ETF and conclude that every ETF is cheaper. Compare funds with the same job and similar holdings.
A commission-free trade can still have a bid-ask spread, and a no-load mutual fund can still have yearly operating costs.
Three questions before choosing
- Do the two funds own similar things?
- What will I pay all-in?
- Will I invest automatically or trade during the day?
Quick answers
Are ETFs always cheaper than mutual funds?
No. Many ETFs are low-cost, but low-cost mutual funds also exist. Compare the exact expense ratio and every other fee.
Are ETFs more tax-efficient?
Some ETFs have historically made fewer capital-gain distributions in taxable accounts. That advantage is not the same inside a tax-advantaged retirement account.
Checked against primary sources
This explanation was checked against the sources below. Rules and limits can change, so check the source before making a decision.
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