Mutual Funds vs. ETFs: Understand The Difference (2024)

FAQs

Mutual Funds vs. ETFs: Understand The Difference? ›

Mutual funds are usually actively managed, although passively-managed index funds have become more popular. ETFs are usually passively managed and track a market index or sector sub-index. ETFs can be bought and sold just like stocks, while mutual funds can only be purchased at the end of each trading day.

With a mutual fund, you buy and sell based on dollars, not market price or shares. And you can specify any dollar amount you want—down to the penny or as a nice round figure, like $3,000. With an ETF, you buy and sell based on market price—and you can only trade full shares.

Unlike mutual funds, an ETF trades like a common stock on a stock exchange. ETFs experience price changes throughout the day as they are bought and sold. *ETFs typically have higher daily liquidity and lower fees than mutual fund shares, making them an attractive alternative for individual investors.

If you're paying fees for a fund with a high expense ratio or paying too much in taxes each year because of undesired capital gains distributions, switching to ETFs is likely the right choice. If your current investment is in an indexed mutual fund, you can usually find an ETF that accomplishes the same thing.

An ETF tracks an index. This means it is managed passively. FOF is managed by a fund manager actively. This means the choice of mutual fund schemes is altered by the fund manager to meet the goals and risk-taking potential of investors.

ETFs have transparent and hidden fees as well—there are simply fewer of them, and they cost less. Mutual funds charge their shareholders for everything that goes on inside the fund, such as transaction fees, distribution charges, and transfer-agent costs.

ETFs can be more tax efficient compared to traditional mutual funds. Generally, holding an ETF in a taxable account will generate less tax liabilities than if you held a similarly structured mutual fund in the same account. From the perspective of the IRS, the tax treatment of ETFs and mutual funds are the same.

Mutual funds offer diversification or access to a wider variety of investments than an individual investor could afford to buy. Investing with a group offers economies of scale, decreasing your costs. Monthly contributions help your assets grow. Funds are more liquid because they tend to be less volatile.

Which is riskier ETF or mutual fund? ›

The short answer is that it depends on the specific ETF or mutual fund in question. In general, ETFs can be more risky than mutual funds because they are traded on stock exchanges.

As we covered earlier, infrequently traded ETFs could have wide bid/ask spreads, meaning the cost of trading shares of the ETF could be high. Mutual funds, by contrast, always trade without any bid-ask spreads.

ETFs may close due to lack of investor interest or poor returns. For investors, the easiest way to exit an ETF investment is to sell it on the open market. Liquidation of ETFs is strictly regulated; when an ETF closes, any remaining shareholders will receive a payout based on what they had invested in the ETF.

But they have some key differences, in particular, how expensive the funds are. Overall, ETFs hold an edge because they tend to use passive investing more often and have some tax advantages. Here's what differentiates a mutual fund from an ETF, and which is better for your portfolio.

ETF owners benefit from liquidity as well as broad diversity in their mutual fund portfolio. There is no lock-in since they are open-ended funds providing you with the option of withdrawing your assets as needed.

Both index funds and ETFs offer investors unique advantages and cater to different investment preferences. While index funds provide simplicity, stability, and cost-effectiveness for long-term investors, ETFs offer greater flexibility, intraday trading options, and potential for active management strategies.

ETFs have transparent and hidden fees as well—there are simply fewer of them, and they cost less. Mutual funds charge their shareholders for everything that goes on inside the fund, such as transaction fees, distribution charges, and transfer-agent costs.

Profits from ETF holdings of over 3 years are categorised as long-term capital gains. The ETF tax rate for these gains is 20% (with the benefit of indexation). The profits, if any, from these ETFs are always considered to be short-term capital gains. They are taxed at the applicable income tax slab rate.

There are 2 basic types of dividends issued to investors of ETFs: qualified and non-qualified dividends. If you own shares of an exchange-traded fund (ETF), you may receive distributions in the form of dividends. These may be paid monthly or at some other interval, depending on the ETF.