Exchange-traded funds and mutual funds offer investors access to broad portfolios of securities. Both investment strategies pool investor money together and invest that money in a single portfolio.
In many ways, ETFs and mutual funds are similar. They have important differences, however, in terms of structure and costs. Take a look at how they differ and which one might be the best choice for your investment portfolio.
What is a mutual fund? Mutual funds sell shares directly to investors. Each share represents an ownership portion of the underlying portfolio, which an investment professional manages. Mutual fund companies price their shares daily, typically after hours.
Fund companies do not issue ETFs directly to shareholders — these funds trade on the public stock exchanges. The price of an ETF stock is determined by its public market price, which might be different from its underlying portfolio price.
What is an index fund? An index fund can be either a mutual fund or an ETF. An index fund invests in securities designed to replicate the performance of a specific stock or bond index.
The two largest mutual funds today are Standard & Poor’s 500 index funds — the SPDR S&P 500 index trust and the Vanguard 500 index fund. Often used as a proxy for the large-cap U.S. market as a whole, the S&P 500 index holds some notable companies, including Apple, Microsoft and Amazon.
Fees vary among funds. Most mutual funds have some type of sales charge, ranging from an upfront commission to a selling fee. Even no-load funds, like Vanguard mutual funds, have low-level management fees and other expenses associated with them.
Since ETFs trade like stocks, investors generally pay a stock commission to buy or sell them. Some companies, however — including Charles Schwab — offer a number of ETFs with no commissions. Like mutual funds, money managers run ETFs, so you’ll have to pay those fees as well.
Mutual Fund vs. ETF
To determine which investments are appropriate for your financial situation you might consider enlisting the help of a financial advisor. Before you do that, familiarize yourself with the differences between funds:
- You can buy or sell ETFs whenever the market is open; mutual funds sell only after market hours. If you anticipate a rapidly rising or falling market, you might want to opt for an ETF because you can trade it quickly.
- Mutual funds typically make taxable distributions at least once per year, often in December — ETFs are often more tax-efficient.
- Many mutual funds allow you to make regular investments from your bank account; ETFs typically require you to make new purchases on the open market.
- A number of mutual funds don’t charge fees to buy or sell and their pricing reflects their underlying investments. ETFs might trade at a premium — meaning you’ll pay more than the underlying stocks and bonds are worth — and they typically charge a commission to buy or sell.
Top-Rated ETFs and Mutual Funds
The largest mutual fund company in the world is Vanguard, with $2.9 trillion of investor assets. Other well-known mutual fund companies include BlackRock, State Street Global and Fidelity.
The Vanguard 500 index fund was the first of its type and now there is a Vanguard ETF dubbed the S&P 500 index ETF. Each company hosts a large lineup of both mutual funds and ETFs.