ETF vs. Mutual Funds: What's the Difference?

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Since ETFs and traditional mutual funds each have their own characteristics and thus their own pros and cons, there’s no clear-cut answer as to which is always better for everyone.

I’ve been a mutual fund investor for nearly 30 years but didn’t buy my first shares in Exchange Traded Funds (ETFs) until very recently.

That’s not surprising.

The first modern mutual fund was created in 1924! They didn’t catch on until the 1980s, but by the early 90s, when I started investing, they were widely known and used.

ETFs, on the other hand, are a far more recent invention, with the first created in 1993 and experiencing very gradual growth.

In recent years, however, ETFs seem to be poised to take over the lead from mutual funds, at least in terms of US assets under management (AUM).

ETFs vs. Mutual Funds – Comparing the Number of Funds and AUM

According to Statista, in 2022, there were 8754 ETFs in the world, with nearly $10 trillion in AUM. Nearly all of those assets are managed by passive index ETFs. According to JP Morgan, active ETFs managed just $412 billion as of the end of 2022, about 4% of the global ETF market.

The NYSE reports that there are 3030 US ETFs, with $5.93 trillion in AUM.

By comparison, Statista reports there are nearly 138,000 mutual funds worldwide, of which 7393 are in the US. The size of the global mutual fund market was over $59 trillion in 2022. Here, just $18.23 trillion, or 31%, are managed passively by index funds.

In the US, mutual funds have a total AUM of about $17.3 trillion, with $4.8 trillion, or 28%, of that in index funds, according to Statista.

ETFs vs. Mutual Funds – Similarities and Differences

ETFs and traditional mutual funds have a lot in common.

Both provide wide diversification, even for small investors.
Either can follow an index or be actively managed, though most ETFs follow indexes while most mutual funds are actively managed.
Both are liquid, though ETFs are more so than mutual funds (see below).
Both can be purchased in retirement accounts or taxable ones.
Both can invest in broad asset classes.
Both charge expenses such as trading costs, management fees, etc. In both cases, index funds are less expensive than actively managed funds.

However, there are many crucial differences.

Availability: ETFs can be purchased and traded on stock exchanges whenever those are open, while mutual funds are sold by their issuer and can only be purchased daily.
Minimum investment: ETFs have no investment minimum except as required by the brokerage (some brokerages allow fractional shares); most mutual funds have minimum required investments that can be hundreds, thousands, or even hundreds of thousands of dollars.
Pricing: ETF pricing changes constantly as a result of supply and demand and aren’t fully determined by the underlying fund investments; mutual funds are priced just once each day the market is open, and the share price or net asset value is determined by the underlying portfolio.
Shorting: Just as with stocks, you can short-sell an ETF; mutual funds cannot be shorted.
Commissions: ETF commissions are what the exchange or brokerage charges, often $0; some mutual funds have so-called sales loads or commissions that can exceed 5% of your investment! These may be charged upfront or when you sell.
Taxation of capital gains: ETFs are not required to distribute gains each year; mutual funds are required to do so. Thus, ETFs are usually more tax-efficient than mutual funds.
Transparency of holdings: ETFs typically disclose their holdings daily to monthly, while mutual funds usually do so monthly to quarterly.

ETFs vs. Mutual Funds – Which Is Best for You?

Given all the above-mentioned similarities and differences, there’s no clear-cut answer that always holds true.

The real answer is both, but only if you use each based on its advantages and disadvantages.

For example, since mutual funds are inherently less tax-efficient, they’re better held in tax-advantaged accounts such as Health Savings Accounts (HSAs); traditional and Roth 401(k), 403(b), 457(b), SEP IRA, and SIMPLE IRA plans; and traditional and Roth IRAs.

ETFS, on the other hand, are well-suited for taxable accounts.

If you’re just starting out and can’t afford the minimum investments of mutual funds, ETFs can easily accommodate your more modest investment size.

If you’re seeking to trade often (generally a bad idea), ETFs are far more amenable to that. In fact, many mutual fund issuers have specific policies in place that prevent trading more often than monthly.

Some Interesting Additional Stats and Reading

According to the Investment Company Institute (ICI), as of 2022, over 16 million American investors (12% of US households) owned ETF shares. Interestingly, more than 8 in 10 of those also held mutual funds.

The ICI also reports that about 30% of ETF AUM are in large-cap US-equity ETFs, a similar fraction was in other US-equity ETFs, and 19% in bond ETFs.

If you want to know more about which ETF issuers are in the top 10, what types of ETFs had the highest recent returns, and what ETF categories saw the biggest recent inflows, check out this CFA Research report.

The Bottom Line

Since ETFs and traditional mutual funds each have their own characteristics, and thus their own pros and cons, there’s no clear-cut answer as to which is always better for everyone.

The above details the similarities and differences between the two, and who would be better served by which in what circumstances.

Disclaimer: This article is intended for informational purposes only, and should not be considered financial advice. You should consult a financial professional before making any major financial decisions.

Disclaimer: This article is intended for informational purposes only and should not be considered financial advice. You should consult a financial professional before making any major financial decisions.

About the Author

Opher Ganel

My career has had many unpredictable twists and turns. An MSc in theoretical physics, a PhD in experimental high-energy physics, a postdoc in particle detector R&D, a research position in experimental cosmic-ray physics (including a couple of visits to Antarctica), a brief stint at a small engineering services company supporting NASA, followed by starting my own small consulting practice supporting NASA projects and programs. Along the way, I started several other micro businesses and helped my wife start and grow her own Marriage and Family Therapy practice. I draw on these diverse experiences to write about personal and small-business finance to help people achieve their personal and business finance goals.

Follow me on Medium (opher-ganel.medium.com).

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This article originally appeared on Wealthtender. To make Wealthtender free for our readers, we earn money from advertisers, including financial professionals and firms that pay to be featured. This creates a natural conflict of interest when we favor their promotion over others. Wealthtender is not a client of these financial services providers.