Mutual Funds vs ETFs: Key Differences Explained
Mutual funds and exchange-traded funds, commonly called ETFs, are investment vehicles that can provide exposure to a collection of underlying securities or other assets. Although they may have similar purposes, there are important differences in how they are bought, sold and managed.
What Is a Mutual Fund?
A mutual fund pools money from investors and invests according to its stated investment objective. The fund may hold stocks, bonds or other eligible assets depending on its strategy.
Mutual fund investors generally buy or redeem units according to the fund's applicable rules. Pricing and dealing arrangements can vary by fund and jurisdiction.
What Is an ETF?
An ETF is an investment fund that is generally traded on an exchange. Investors can buy and sell ETF units through the market during trading hours, subject to market availability and applicable rules.
Both mutual funds and ETFs can provide diversified exposure to multiple investments, but their trading, pricing, costs and structure may differ.
Key Differences Between Mutual Funds and ETFs
| Feature | Mutual Funds | ETFs |
|---|---|---|
| Trading | Generally purchased or redeemed according to fund dealing rules. | Generally bought and sold on an exchange during market hours. |
| Pricing | Often based on the fund's applicable net asset value calculation. | Market prices can change throughout the trading session. |
| Access | Available through fund platforms, distributors or other channels depending on the market. | Usually require access to an exchange through a broker or other trading arrangement. |
| Costs | May include fund expenses and other applicable charges. | May include fund expenses, brokerage costs and bid-ask spreads. |
| Strategy | Can be actively managed or passively managed. | Can also be actively managed or passively managed. |
How Are They Similar?
Both mutual funds and ETFs may provide access to a group of underlying investments through a single product. Depending on the fund, they may track an index, follow an active investment strategy or focus on a particular market, sector or asset class.
The level of diversification depends on the specific holdings of the fund. Owning a fund does not automatically eliminate investment risk.
Two funds may both provide exposure to the same market index. However, one may be structured as a mutual fund while the other may trade as an ETF. Their trading process, expenses and market pricing can differ even if their underlying objectives are similar.
Costs and Expenses
Investors may consider multiple types of costs. These can include expense ratios, management fees, brokerage charges, transaction costs and bid-ask spreads where applicable.
A lower stated expense ratio does not necessarily mean a particular investment will produce better returns. Costs should be considered together with investment objectives, risks, tracking differences and other relevant factors.
Market Pricing and NAV
The net asset value, or NAV, generally represents the value of a fund's underlying assets after relevant liabilities are considered, according to the fund's methodology.
ETF market prices can trade above or below their reported NAV. The difference may depend on market conditions, liquidity and other factors.
Risks to Consider
- The value of the underlying investments can rise or fall.
- Different funds can have different levels of diversification and concentration.
- Costs and transaction expenses can affect returns.
- ETFs can experience market price movements and liquidity-related risks.
- Index-tracking funds can experience tracking differences.
- Past performance does not guarantee future results.
Which One Is Better?
Neither mutual funds nor ETFs are automatically better for every investor. The appropriate choice can depend on the investment objective, time horizon, costs, access, trading preferences, tax considerations and tolerance for risk.
The specific fund and its underlying holdings may be more important than simply whether it is structured as a mutual fund or an ETF.
Questions to Consider
- What assets does the fund invest in?
- Is the fund actively or passively managed?
- What are the total costs involved?
- How diversified or concentrated are the holdings?
- How easily can the investment be bought or sold?
- What risks are associated with the underlying assets?
- How does the investment fit within the overall portfolio?
Key Takeaways
- Mutual funds and ETFs can both provide exposure to multiple investments.
- ETFs generally trade on exchanges during market hours.
- Mutual funds generally follow their own subscription and redemption procedures.
- Costs, pricing and liquidity can differ between the two structures.
- Both can involve investment risk and possible losses.
- The specific investment objective and holdings are important when evaluating either option.