ETF vs. Mutual Fund: What Is the Difference? In Plain Words

What both kinds of fund are

Both mutual funds and ETFs are pooled investments. Many investors put money into a single fund. The fund invests in stocks, bonds, other assets, or some combination of these.

Each fund share stands for one investor’s share of the whole fund. FINRA says both kinds of fund offer investors a stake in a diversified portfolio. Diversified means the money is spread across many holdings instead of resting on one company. Investor.gov says each share represents the investor’s proportionate ownership of the fund’s portfolio — and of the gains or losses of that portfolio.

Both kinds of fund are investment companies. Both must file registration statements with the SEC (the U.S. Securities and Exchange Commission). Registration gives investors protections. One protection is disclosure: key information about a fund is set out in a document called a prospectus. You can get a fund’s prospectus free of charge. It is in the SEC’s EDGAR database. You can also get it from the fund itself, on the fund website or by calling the fund.

Both kinds of fund are typically managed by SEC-registered investment advisers. FINRA adds one plain point: you do not get to choose the securities in either an ETF or a mutual fund. You can find a fund’s top holdings and other information in the fund’s prospectus and through online resources.

What is the same for both

• Diversification. Both kinds of fund can spread investments across a wide range of companies or industry sectors. Investor.gov says this can help lower your risk if one company fails. But some mutual funds and ETFs are less diverse than others. They may hold fewer investments. Some ETFs even track the performance of a single stock.
• Liquidity. Liquid means shares can be sold easily and quickly. Investor.gov calls both kinds of fund liquid investments. FINRA says the same in its own words: both are quite liquid.
• Low starting amounts. Some mutual funds set relatively low dollar amounts to buy shares. ETF shares can often be bought on the market for relatively low dollar amounts too.
• Passive or active. Both kinds of fund can follow a passive strategy or an active strategy. A passive strategy seeks to achieve about the same return as a particular index. An index is a set list used to stand for part of the market. A passive fund can be run by buying all of the securities in the index, or a representative sampling of them. Passively managed funds are typically called index funds. An active strategy relies on the skill of an investment manager. The manager may buy or sell investments without conforming to an index.
• Risk. FINRA states this plainly: both mutual funds and ETFs can lose money. How a fund performed in the past is not an indication of how it will perform in the future.

How you buy and sell: the main difference

Mutual funds. Investors buy mutual fund shares from the fund itself, or through a financial intermediary, such as a broker. Mutual fund shares are “redeemable.” That means investors can sell shares back to the fund. FINRA says mutual fund investors can usually redeem their shares with ease on a daily basis. You can hold mutual fund shares directly with the fund.

One more mutual fund point: for some mutual funds, buyers can choose from multiple types of shares. These are called share “classes.” Each share class has a different fee and expense structure.

ETFs. Retail investors — ordinary individual investors — can buy and sell ETF shares only in market transactions. That means on a national stock exchange. Unlike mutual funds, ETFs do not sell shares directly to retail investors. ETFs also do not redeem shares directly from retail investors. FINRA says ETF investors buy or sell shares on an exchange, as they would any other publicly traded stock. Investor.gov adds: you need a brokerage account to buy, sell, and hold ETF shares.

FINRA gives this trading pattern a name: “intraday liquidity.” Intraday means within the trading day. With an ETF, pricing is continuous — it goes on all day. So you do not face the possible price uncertainty that comes with end-of-day mutual fund pricing.

How the price is set

Both kinds of fund use a measure called NAV. NAV stands for net asset value. FINRA defines it this way: NAV is the per-share value of the fund’s assets minus its liabilities. Assets are what the fund holds. Liabilities are what the fund owes.

Mutual fund pricing. Investors buy or sell mutual fund shares at the NAV per share, plus or minus any fees and charges that apply. NAV is typically calculated at the end of each business day. FINRA says mutual funds are required by law to price their shares at NAV each business day. They typically do so after the major U.S. exchanges close. You can send in a buy or sell order at any point during the business day. But you will not know the exact price per share you will pay or receive until the end of the business day.

ETF pricing. ETFs must also calculate their NAV per share every business day. But retail investors do not trade at that NAV. They buy and sell ETF shares at market prices, plus or minus any fees and charges that apply. An ETF’s market price may be higher than its NAV per share. That is called buying at a premium. The market price may be lower than its NAV per share. That is called selling at a discount. An ETF’s market price also changes during the trading day. Investor.gov says the market price generally stays close to the ETF’s end-of-day NAV, but it may vary significantly. You can get real-time, or close to real-time, ETF prices from financial websites or by calling a broker.

When you sell, the same split applies. A mutual fund investor can sell shares back to the fund at the next calculated NAV on any business day, minus any fees and charges on redemption. An ETF investor can sell shares on the market at any time the market is open, at the market price, minus any fees and charges at the time of sale.

Fees and expenses

Investors in both kinds of fund must pay fees and expenses. That is true regardless of how the fund performs. Depending on the type of fund, these can include sales charges or brokerage commissions, annual fees, management fees, and other expenses. Investor.gov states the result in one line: all fees and expenses reduce the return on your investment.

FINRA uses one shared name for part of these costs. Mutual funds and ETFs both charge “Annual Fund Operating Expenses.” These are also known as expense ratios. An expense ratio is expressed as a percentage. FINRA adds that mutual funds often charge other fees. It also says there are generally brokerage commissions when you buy or sell an ETF.

How the fees reach you also differs:

• Mutual funds charge some fees indirectly. The fees are deducted from fund assets. Management fees are one example. When fees are paid out of fund assets, the value of the fund goes down, and the value of all the investors’ shares goes down. Mutual funds charge other fees directly to investors. Examples are fees for buying, selling, or exchanging shares, and periodic account fees.
• ETFs also charge some fees indirectly, including management fees. But ETFs generally do not charge fees directly to investors for buying or selling ETF shares. There may still be other transaction fees and costs. One example is a commission paid to a broker for each purchase or sale of ETF shares.

Investor.gov’s advice on this point is about reading, not picking: it is always important to consider the total fees and expenses you will be charged in connection with any investment.

Taxes, in plain words

A taxable account is an ordinary account, such as a brokerage account. A tax-advantaged account is an account with special tax treatment, such as a 401(k) or an IRA.

In a tax-advantaged account: Investor.gov says there is no tax difference between an ETF and a mutual fund if the investment is held in a tax-advantaged account, such as a 401(k) or IRA. Investor.gov also notes that taxes on certain ETFs have historically been lower than those for mutual funds — but that difference does not apply inside a tax-advantaged account.

In a taxable account: Mutual fund investors generally have to pay taxes on any capital gains distributions they receive from the mutual fund. A capital gains distribution is a distribution the fund makes to its investors out of gains. ETF investors may also have to pay taxes on capital gains distributions from the ETF. But many ETFs buy and sell portfolio securities in in-kind exchanges rather than for cash. An in-kind exchange trades the securities themselves instead of cash. Because of that, ETFs typically have fewer capital gains distributions than mutual funds. So ETF shareholders typically face lower taxes than mutual fund shareholders on a similar investment held in a taxable account.

FINRA describes the same idea from the investor’s side. With an ETF, an investor can choose when to sell shares. That choice decides if or when a capital gains tax liability occurs. The investor still has to pay taxes on any realized capital gains when they do sell. The investor is also responsible for reporting any dividend and interest payments they receive. Mutual fund investors can also choose when to sell their own shares. But with mutual funds, a tax liability can also occur when the fund manager sells holdings that carry built-up gains.

The difference, side by side

• Where you trade: mutual fund shares come from the fund itself, or through an intermediary like a broker, and are sold back to the fund. ETF shares trade only on a national stock exchange, between buyers and sellers.
• When you can trade: mutual fund orders are priced once a day, at the end of the business day. ETF shares can be bought and sold at any time the market is open.
• What price you get: a mutual fund trade uses the NAV per share for that day. An ETF trade uses the market price at that moment, which may be above or below the ETF’s NAV.
• What account you need: mutual fund shares can be held directly with the fund. ETF shares need a brokerage account.
• Taxes in a taxable account: both kinds of fund can pass capital gains distributions to investors. ETFs typically have fewer of them, because many ETFs use in-kind exchanges instead of cash trades.