Mutual funds and exchange-traded funds (ETFs) are more similar than not.
They’re both baskets of many individual stocks, bonds, and other securities that help spread out your investments in the stock market. Instead of hand-selecting singular assets on your own, you can use either type of fund to instantly get hundreds, thousands, or tens of thousands of different stocks and bonds.
“Imagine going to a restaurant and wanting to try a little of everything on the menu. Instead of purchasing an individual dish, you decide to buy the sampler plate,” says Rita-Soledad Fernández Paulino, a financial educator at Wealth Para Todos. “Mutual funds and ETFs are the sampler plates.”
Read on to learn more about mutual funds and ETFs and how to decide which one is right for you.
Mutual Funds vs. ETFs: Similarities and Differences
Investors love both mutual funds and ETFs because of the way they spread out money in the stock market. This lowers your risks and prevents you from investing in just one stock, which can hurt you should that company take a downturn.
Just a few key differences set mutual funds and ETFs apart.
How they’re managed
Both ETFs and mutual funds can be index funds, meaning they track the performance of a certain market, or index. There are loads of index funds, but ones that reflect the S&P 500 (the 500 largest publicly traded companies in the U.S.) are often recommended.
Both mutual funds and ETFs are low-risk investments, even for newbies. Beginners might want to look into ETFs first before graduating into mutual funds, even though both perform about the same.
The best ETFs are passively managed, which means they track a specific index rather than have a fund manager pick the stocks. These ETFs will have lower expense ratios, or fees, and usually have no commissions, which make for expert favorites. There is usually no minimum required to start investing with ETFs, and ETFs also offer investors tax advantages.
On the flip side, some mutual funds can be actively managed, usually by an account manager. So the difference here is it can cost more to buy.
How they’re traded
Like stocks, ETFs are bought and sold on a stock exchange. So ETFs see price fluctuations constantly throughout the day. Mutual fund orders only go through once a day, where buyers and sellers get the same price.
“ETFs are purchased and traded like stocks which means you can purchase for the price of one share,” Paulino says. “Mutual funds are purchased for a flat price. This can make purchasing ETFs more affordable.”
What they cost
ETFs generally have lower fees than mutual funds and lower minimum purchases. “Returns may fluctuate, but costs are more constant with ETFs,” says Cait Howerton, Certified Financial Planner and Lead Planner at Facet Wealth.
You can buy an ETF for as little as the cost of one share, and that cost varies depending on the ETF. For instance, it could be a few dollars or a few hundred dollars.
Many mutual funds have minimum initial investments that aren’t based on the fund’s share price. Remember mutual fund orders go through once a day, so they have a flat dollar amount.
When You Can Buy Mutual Funds and ETFS
You can buy mutual funds and ETFs through a bank, investment company, fund manager, brokerage account, or any other company that buys and sells them. If you have actively managed accounts, you can contact your account manager about buying specific ones.
Do ETFS and Mutual Funds Pay Dividends?
Both mutual funds and ETFs have the capacity to pay out dividends, but it depends on each fund.
If a mutual fund or ETF has a stock or another security that pays its shareholders through dividends, then that mutual fund or ETF will pay dividends back to you, the investor. You can also earn capital gains through a mutual fund or ETF.
Which One Is Safer?
Both mutual funds and ETFs are considered low-risk investments compared to cherry-picked stocks and bonds. While investing in general always carries some level of risk, both mutual funds and ETFs carry about the same level. It depends on the individual mutual fund and ETF you’re investing in.
“Neither an ETF nor a mutual fund is safer simply due to its investment structure,” Howerton says. “Instead, the ‘safety’ is determined by what the ETF or the mutual fund owns. A fund with a larger exposure to stocks is typically going to be riskier than a fund with a larger exposure to bonds.”
Since some mutual funds can be actively managed, there’s a chance those funds can both outperform and underperform in the stock market, Paulino says.
Mutual Funds or ETFs: Which One Should You Choose?
The fund you choose depends on many factors, like the type of investor you are, the fund, the type of account you have, and your overall strategy. Howerton says ETFs are a great place to start.
“Because of the much lower costs, ease of purchase, and tax efficiency, ETFs are hard to beat,” she says. The overhead on ETFs is much lower compared to mutual funds, which could be a deciding factor. Pay attention to expenses and fees as you’re choosing between mutual funds and ETFs. Every little charge adds up.
“A newbie investor should start off with passively managed mutual funds or ETFs that have low expense ratios,” Paulino says. “Anything below 0.5% is great and keep in mind that some expense ratios can be as low as 0.02%. In order to reduce tax liability, they should start by investing in tax-advantaged accounts like a Roth IRA.”