Explainer · Funds, ETFs & Indexes
ETFs vs mutual funds: what actually differs
ETFs and mutual funds can hold exactly the same stocks. What differs is the wrapper: where you buy it, what price you get, what you pay and how it is taxed.
Quick answer
Both pool investors' money into one portfolio [1]. You buy mutual fund shares from the fund at the next calculated NAV, set once a day [2]. You buy ETF shares on an exchange at a market price that changes all day and can differ from NAV [1].
Key points
- Mutual fund orders fill at the next calculated net asset value (NAV), usually computed once each business day after the major U.S. exchanges close [5].
- ETF shares trade on an exchange at market prices any time the market is open, and that price can sit above or below NAV [1].
- Both charge ongoing fees through an expense ratio; ETF trades can also cost a commission and the bid-ask spread [3].
- Many ETFs use in-kind exchanges, so they typically make fewer capital gains distributions than mutual funds [1].
- Either wrapper can be an index fund or an actively managed fund [1].
On this page
What is the difference between an ETF and a mutual fund?#
Start with what is the same. Both let many investors pool their money into a single fund that invests in stocks, bonds, other assets or a mix, and both are investment companies that must file registration statements with the SEC [1]. A mutual fund is an SEC-registered open-end investment company [2]; an ETF is a type of exchange-traded investment product available to retail investors [3].
The differences are in the mechanics. You buy mutual fund shares from the fund itself or through an intermediary such as a broker [1]. Retail investors can buy and sell ETF shares only in market transactions, on a national stock exchange [1]. Almost everything else follows from that one difference.
The main differences side by side:
| Feature | Mutual fund | ETF |
|---|---|---|
| Where you buy and sell | From and back to the fund, or via a broker | On a stock exchange, through a broker |
| Price you get | Next calculated NAV, plus or minus fees | Market price at the moment of the trade |
| When the price is set | Once a business day, typically after the close | Continuously while the market is open |
| Price vs NAV | At NAV, before any fees | Can trade at a premium or discount |
| Trading costs | Possible sales loads or redemption fees | Possible commission plus bid-ask spread |
| Capital gains distributions | Distributed to investors each year | Typically fewer, because of in-kind exchanges |
How is the price of each one set?#
A mutual fund's price is its net asset value per share. NAV is the fund's total assets minus its total liabilities, and the per-share figure is NAV divided by the shares outstanding [5]. Mutual funds generally must calculate it at least once every business day, typically after the major U.S. exchanges close [5]. Your order fills at the next calculated NAV, plus any fees charged at purchase [2]. So if you place an order at 11 a.m., you typically will not know your exact price until after the close.
An ETF has a NAV too, but you do not trade at it. You trade at whatever buyers and sellers agree on during the day [1]. The SEC notes that an ETF's market price typically will be more or less than its NAV per share, which is called trading at a premium or a discount [3].
What keeps an ETF's price close to its NAV is a set of firms called Authorized Participants. To create shares, an Authorized Participant deposits a basket of securities and cash with the ETF and receives ETF shares; to redeem, it buys a large block of ETF shares on the market and delivers them to the fund [3]. The SEC says the expected result of this arbitrage is that the market price moves back in line with NAV [3]. Expected is not the same as guaranteed.
How do you buy and sell each one?#
A mutual fund order is sent to the fund, directly or through a broker, and you can sell shares back to the fund at the next calculated NAV on any business day [2].
An ETF is bought like a stock, through a brokerage account. ETF investors can sell on the market any time the market is open [1], and ETF shares can often be bought for relatively low dollar amounts [1]. Because you trade at market prices, the order types explained in market orders vs limit orders apply.
- Read the prospectus first
Both fund types must include a standardized fee table in their prospectus [4]. Note the expense ratio and any sales load or redemption fee.
- Mutual fund: place the order
It fills at the next calculated NAV after the order is received, plus any purchase fees [2].
- ETF: check the bid and ask
The bid is lower than the ask, and the difference is the spread you pay to trade [3].
- ETF: consider a limit order
A limit order buys only at your price or better, but it is not guaranteed to fill [6].
Which one costs more to own and to trade?#
Both charge an ongoing fee called the expense ratio, expressed as a percentage of the fund's average net assets [4]. It is taken from fund assets, which lowers the value of every investor's shares [4], and investors in both types pay fees regardless of how the fund performs [1]. The SEC says ETFs have tended to be less expensive to operate than mutual funds that invest in a similar manner, and typically pass the savings on as lower total fees [3]. That is a tendency, not a rule; compare the actual funds you are considering.
The costs of getting in and out differ. Some mutual funds charge sales loads, which compensate the selling broker similar to a commission, or a redemption fee when you sell back to the fund [4]. With an ETF you may pay brokerage commissions and additional trading costs when you buy and sell [3], including the spread. Learn more in expense ratios explained.
- Cost to buy at the ask
- $5,002.00100 x $50.02, calculated
- Proceeds if sold at the bid
- $4,998.00100 x $49.98, calculated
- Spread cost of a round trip
- $4.000.08% of the purchase price, before any commission, calculated
How are ETFs and mutual funds taxed differently?#
The main difference is how often a fund hands you a taxable distribution. When a mutual fund sells holdings at a profit, at the end of the year it distributes those capital gains, minus any capital losses, to investors [2]. In a taxable account, fund investors may have to pay taxes on capital gains distributions [1].
Many ETFs buy and sell portfolio securities in in-kind exchanges rather than for cash, so they typically have fewer capital gains distributions and lower taxes than mutual funds [1]. Fewer is not none: ETF investors in a taxable account may also have to pay taxes on capital gains distributions [1]. How much tax you owe depends on your account and your situation.
Are leveraged and inverse ETFs the same kind of product?#
No. They trade on the same exchanges but do something very different. Leveraged ETFs seek to deliver multiples of the daily performance of the index they track [7]. Because they reset daily, the SEC warns that their performance over a period longer than one day can differ significantly from their stated daily objectives [7].
Mistakes beginners make with ETFs and mutual funds#
- Expecting a mutual fund to fill at today's quote
Your order fills at the next calculated NAV, which is usually set after the close [5].
Frequently asked questions#
Is an ETF safer than a mutual fund?
Can I sell a mutual fund during the day?
Why does my ETF price differ from its NAV?
Are ETFs always cheaper than mutual funds?
No. The SEC says they have tended to be less expensive to operate than mutual funds that invest in a similar manner [3], but you may also pay commissions and the spread when you trade. Compare the specific funds.
The bottom line#
ETFs and mutual funds are two wrappers for the same idea: a pooled, diversified portfolio. Choose based on how you want to buy, what each option costs in total and how it is taxed in your account, then judge what the fund actually holds. Neither wrapper protects you from losses in the market, and leveraged or inverse ETFs are specialized tools that are generally not meant to be held for long.
Sources
- Characteristics of Mutual Funds and Exchange-Traded Funds (ETFs).
- Mutual Funds (Investor.gov investment products).
- Updated Investor Bulletin: Exchange-Traded Funds (ETFs).
- Mutual Fund and ETF Fees and Expenses (Investor Bulletin).
- Net Asset Value (Investor.gov glossary).
- Understanding Order Types | Investor.gov.
- Updated Investor Bulletin: Leveraged and Inverse ETFs.
- Investor Bulletin: Index Funds.
Education only. This page is not investment, tax or legal advice. Stocks can lose value. See our risk disclosure.
