ETF vs Mutual Fund

1. Trading Mechanics: Intraday vs End-of-Day

ETFs trade on stock exchanges throughout market hours (9:30 AM - 4:00 PM ET). You can buy or sell shares at any moment, place limit orders, stop-loss orders, or even short-sell. The price fluctuates continuously based on supply and demand, similar to individual stocks. You need a brokerage account to trade ETFs.

Mutual Funds only execute trades once per day after the market closes. When you place an order at 10 AM or 3 PM, it doesn't matter — you receive the closing price (NAV) calculated at 4 PM ET. You won't know the exact price when you place your order. Many mutual funds can be purchased directly from the fund company or through retirement plan platforms without a brokerage account.

Example: If the market crashes mid-day, ETF investors can sell immediately to cut losses. Mutual fund investors must wait until the 4 PM NAV calculation and accept whatever price results.

2. Expense Ratios and Cost Structure

ETFs typically have lower expense ratios, often ranging from 0.03% to 0.20% for broad index funds. For example, the Vanguard S&P 500 ETF (VOO) charges just 0.03% annually. There are no load fees (sales commissions), but you pay standard brokerage commissions when buying/selling, though most brokers now offer commission-free ETF trading. The bid-ask spread (difference between buy and sell price) is an additional hidden cost.

Mutual Funds have higher expense ratios, especially actively managed funds which average 0.60%-1.50%. Index mutual funds are cheaper (0.05%-0.20%), but still typically higher than equivalent ETFs. Some mutual funds charge front-end loads (sales fee when buying, typically 3%-5.75%) or back-end loads (fee when selling). No-load funds skip these sales charges. There are no brokerage commissions or bid-ask spreads.

Cost Example: On a $10,000 investment over 20 years with 7% returns, a 0.05% expense ratio costs $209, while a 1.00% expense ratio costs $3,926 — a difference of $3,717.

3. Tax Efficiency: Capital Gains Distribution

ETFs are highly tax-efficient due to their unique "in-kind" creation and redemption mechanism. When institutional investors (Authorized Participants) redeem ETF shares, they receive the underlying securities instead of cash. This avoids triggering capital gains within the fund. ETF investors typically only pay capital gains when they sell their own shares. Many ETF investors hold for years without receiving unexpected tax bills.

Mutual Funds distribute capital gains to all shareholders when the fund manager sells securities at a profit — even if you just bought in and haven't sold anything yourself. Active mutual funds with high turnover can distribute significant capital gains annually, creating tax bills in taxable accounts. This is especially frustrating if the fund had negative returns but still distributed gains from earlier trades.

Real Impact: In 2021, some actively managed mutual funds distributed capital gains exceeding 20%-30% of their NAV, forcing shareholders to pay taxes on gains they never realized. Equivalent ETFs distributed near-zero capital gains.

4. Minimum Investment Requirements

ETFs require purchasing at least one full share. Share prices typically range from $25 (sector ETFs) to $500+ (leveraged or niche ETFs). Popular index ETFs like SPY trade around $400-500 per share, while VOO trades around $400. Some brokers now offer fractional share trading, allowing investments of any dollar amount (e.g., $50 in SPY). This makes ETFs accessible to small investors.

Mutual Funds often have minimum initial investments of $1,000-$3,000, with some premium funds requiring $10,000-$100,000. However, employer retirement plans (401(k), 403(b)) often waive minimums entirely. Some fund companies like Fidelity and Schwab offer $0 minimum investments for their index mutual funds. Automatic investment plans may reduce minimums to $50-$100.

5. Management Style and Investment Strategy

ETFs are predominantly passive, index-tracking funds (estimated 90%+ of ETF assets). They aim to match the performance of an index like the S&P 500, Total Stock Market, or MSCI World. This passive approach keeps costs low. While actively managed ETFs exist and are growing, they still represent a minority of the market.

Mutual Funds offer a full spectrum from passive index funds to actively managed strategies. Actively managed mutual funds employ portfolio managers who research companies, make stock selections, and attempt to outperform market benchmarks. This active management comes with higher fees but offers potential (though not guaranteed) for above-market returns. Many investors prefer mutual funds for access to specialized active strategies.

Performance Reality: Research consistently shows that 80%-90% of actively managed mutual funds underperform their benchmark index over 10-15 year periods, especially after accounting for fees.