The main differences between ETFs and mutual funds:
- ETFs can be bought and sold during the trading day, whereas mutual funds can only be traded at the end of the day.
- Both ETFs and mutual funds both offer diversification.
- ETFs generally have lower expense rations than mutual funds.
- Mutual funds are actively managed, whereas most ETFs are passively managed.
If you're diving into the world of investing, you've probably heard about ETFs (Exchange-Traded Funds) and mutual funds. They both offer great ways to invest in a diversified mix of assets, but they have some key differences that every investor should understand.
So, what’s the deal? ETF vs mutual fund - what’s better for you? Let’s break it all down in a way that actually makes sense!
How ETFs and Mutual Funds Are Alike
Diversification: Both ETFs and mutual funds offer investors instant diversification.This is a huge plus for both. With just one investment, you're spreading your risk across many companies or even entire markets. It’s a great way to avoid putting all your eggs in one basket.
The key differences
Trading Mechanics
ETFs trade all day long on exchanges, just like stocks. You can react to real-time price changes. Mutual funds however, trade once a day at the market's close, based on the end-of-day price (NAV).
Cost & Fees
ETFs generally have lower ongoing fees (expense ratios). You might pay commissions per trade (though many are commission-free now) and a small bid-ask spread. In contrast, mutual funds can have higher expense ratios, plus potential "loads" (sales charges) when you buy or sell. "no-load" options do exist though, which are a great way to keep costs down.
Tax Treatment
ETFs can often be more tax-efficient in taxable accounts. Their structure typically means fewer capital gains distributions passed to you. Mutual funds however can be less tax-efficient. Fund managers sometimes trigger capital gains distributions for all shareholders, even if you didn't sell your shares.
Minimum Investments & Auto-Invest
With ETFs, you can often start with just one share, making them very accessible. Automated regular investments can be a bit trickier to set up. Mutual funds on the other hand often have higher minimum initial investments, but they're excellent for easy, automatic recurring investments.
Management
Many ETFs are passive in that they track an index. You can also invest in actively managed ETFs but these are far less common. In contrast, mutual funds are usually actively managed, with a fund manager or management team to pick and choose the investments in the fund.
| Feature |
ETFs |
Mutual Funds |
| Trading |
ETFs are traded like stocks during the day, at your convenience.
|
Mutual funds can only be bought and sold at the end of the day.
|
| Expense ratios |
Ideal for an investor with a smaller budget, ETFs generally have lower expense ratios.
|
Mutual funds usually have higher expense ratios than ETFs.
|
| Tax Efficiency |
ETFs are usually quite tax-efficient, thanks to fewer capital gain distributions.
|
Mutual funds distribute capital gains more frequently, which could lead to unexpected tax bills.
|
| Investment minimums |
The minimum investment for ETFs is usually very low, as you usually need enough for just one share. Some brokers offer fractional shares, so this minimum amount can go even lower. |
Mutual funds generally have a higher minimum investment requirement than ETFs |
| Automatic Investing |
Some brokers may offer automatic investing for ETFs. |
Mutual funds are excellent for easy, automatic recurring investments. You can easily set up regular transfers from your bank account. |
| Management Style |
ETFs can be either passively managed (tracking an index) or actively managed (with a fund manager picking investments). |
Mutual funds can be passively or actively managed, but it's more common for them to be actively managed. |
How ETFs Work: Trade Like a Stock
ETFs are the cool, flexible option in the investing world. They trade on stock exchanges, which means they can be bought and sold just like regular stocks.
Examples of popular ETFs
Here are some well-known ETFs to consider:
- SPDR S&P 500 ETF (SPY) – One of the oldest and most widely traded ETFs, it tracks the S&P 500 and offers broad market exposure.
- Vanguard Total Stock Market ETF (VTI) – Covers the entire U.S. stock market, from large caps to small caps, making it a great diversified choice.
- Invesco QQQ Trust (QQQ) – Tracks the Nasdaq-100, giving you exposure to top tech companies like Apple, Microsoft, and Google.
- iShares MSCI Emerging Markets ETF (EEM) – Provides access to stocks in emerging markets like China, Brazil, and India.
- ARK Innovation ETF (ARKK) – A more actively managed ETF focused on disruptive and innovative technology stocks.
These ETFs offer a mix of broad market exposure and sector-specific investments, allowing you to tailor your portfolio based on your risk tolerance and financial goals.
Key Benefits of ETFs
✔ Flexibility – You can trade ETFs anytime the market is open. ✔ Lower Costs – Many ETFs have super-low expense ratios compared to mutual funds. ✔ Tax Advantages – ETFs are structured in a way that reduces capital gains taxes. ✔ Diversification – A single ETF can hold hundreds or thousands of stocks or bonds.
Drawbacks of ETFs
✖ Potential Trading Fees – Some brokers charge commissions (though many now offer commission-free ETFs like Nemo Money). ✖ Price Fluctuations – Since ETFs trade throughout the day, their prices change constantly.
How Mutual Funds Work: The Set-It-and-Forget-It Option
Mutual funds are more traditional. Instead of being traded throughout the day, they settle once at the end of the trading day at a set price (NAV).
Examples of popular mutual funds
If you're considering mutual funds, here are some well-known ones that investors love:
- Vanguard 500 Index Fund (VFIAX) – One of the most popular mutual funds, tracking the S&P 500 with a low expense ratio.
- Fidelity Contrafund (FCNTX) – An actively traded mutual fund focusing on growth stocks.
- T. Rowe Price Blue Chip Growth Fund (TRBCX) – Invests in large, well-established companies with high growth potential.
- Dodge & Cox Stock Fund (DODGX) – A value-focused mutual fund investing in solid, undervalued companies.
- American Funds Growth Fund of America (AGTHX) – A growth-oriented mutual fund investing in a mix of U.S. and international companies.
These funds offer a variety of investment styles, from passive index tracking to actively managed growth-focused strategies.
Key Benefits of Mutual Funds
✔ Great for Long-Term Investors - Since you’re not worried about intraday price movements, mutual funds encourage long-term investing. ✔ Automatic Investing – Many mutual funds allow you to set up automatic investments and withdrawals. ✔ Professional Management – Many mutual funds are actively managed, meaning experts pick and choose the stocks or bonds inside the fund - these experts aim to outperform the market, so investors might see higher returns.
Drawbacks of Mutual Funds
✖ Higher Fees – Actively managed funds come with higher expense ratios. ✖ Less Flexible – You can only buy or sell at the end of the trading day. ✖ Potential Tax Distributions – You may owe taxes on capital gains distributions, even if you didn’t sell any shares.
Which Should You Choose?
Now that you know the difference between ETFs and mutual funds, how do you choose? It all depends on your investing style and goals.
Consider an ETF if
✅You want the ability to buy and sell during the day. ETFs can be traded just like stocks can during the day, so this makes them a better option if you don’t like the idea of not being able to trade during the day.
✅You prefer lower costs and fewer tax headaches. ETFs generally are more tax efficient and have lower expense ratios, making them a great option for those looking to avoid paying high fees.
✅You’re comfortable managing your own trades in an investment app. Some investors might find this more fun, and beginners might find that it helps them develop their understanding of the market.
Consider a mutual fund if
✅ You’re investing for the long term and don’t need to trade often. Mutual funds can only be traded at the end of the day, so if you’re more into day trading this kind of investment option might not be suitable for you.
✅ You want to set up automatic contributions. Mutual funds are a great choice for investors looking to regularly top up their investment.
✅ You like the idea of having a professional manage your investments. Most mutual funds are actively managed, which can take the stress off for some investors.
Can You Use Both?
Absolutely! Many investors combine ETFs and mutual funds to create a well-balanced portfolio. You might use mutual funds for retirement savings (think: 401(k) or IRA) and ETFs for more flexible, taxable investment accounts.
The Bottom Line
Both ETFs and mutual funds offer great ways to invest in a diversified portfolio without having to pick individual stocks. The right choice depends on your needs:
- Want flexibility and low costs? Go for ETFs.
- Prefer a hands-off, long-term approach? Mutual funds might be the way to go.
FAQs
Q: Is it better to own individual stocks or mutual funds?
It really depends on your goals and how involved you want to be!
- Individual stocks: If you enjoy researching companies, staying updated on market news, and have the time to actively manage your investments, buying individual stocks can offer higher potential returns and give you direct control. However, it's generally more risky.
- Mutual funds: If you prefer a more hands-off approach, or you're looking for instant diversification without the hassle of picking individual companies, mutual funds are a fantastic choice. For this reason, ETFs could also be a great pick for you.
Q: Are ETFs or mutual funds more tax-efficient?
- ETFs are typically structured in a way that minimizes how often they have to sell underlying investments to meet redemptions. This means they tend to distribute fewer capital gains to you, which can lead to a lower tax bill each year depending on your country’s taxation.
- Mutual funds, particularly actively managed ones, sometimes have to sell investments more frequently to manage cash flow or rebalance their portfolio. When they do, they can generate capital gains that are then distributed to all shareholders, potentially creating a tax liability for you even if you haven't sold your own fund shares.
So, if you're investing in a taxable account, ETFs are generally more tax efficient.
No matter what you choose, investing through an investment app like Nemo Money makes it easier than ever to start building wealth. The key is to get started and stay consistent - because time in the market beats timing the market every time!
New Nemo Money users can grab our registration bonus up to a maximum of $50 on first deposit. Terms and conditions apply.
Han Tan
Han Tan is a seasoned financial journalist and news presenter renowned for his expertise in global markets. With a career highlighted by interviews with prominent figures and recognition from major media outlets like CNN and Reuters, he delivers insightful analysis on market news and macroeconomic trends to clients and international audiences. Han's sharp commentary on currencies, stocks, and commodities is familiar to viewers of Bloomberg TV Malaysia, BFM 89.9, and NTV7, cementing his sterling reputation in the industry.
