Exchange traded funds (ETFs) and mutual funds are popular investment vehicles that allow you to invest in diversified portfolios of assets. But what sets ETFs and mutual funds apart? And which is right for you?
ETFs and mutual funds share some foundational traits. Here are the three biggest:
Both ETFs and mutual funds are professionally managed baskets of individual stocks or bonds. That is, fund managers select and manage the fund's holdings according to the guidelines set forth in the fund’s prospectus.
And what about the majority of ETFs and many mutual funds that are passive index funds? Portfolio managers make sure these funds don’t stray too much from their benchmark indices. In addition to benefitting from the manager’s investment expertise, you save time and effort when you choose professional management.
There are thousands of ETFs and mutual funds designed to help investors pursue their financial goals, whether to gain global market exposure, generate income, or even access difficult-to-reach markets. You can invest broadly in a total market fund, more narrowly in a high-yield bond fund, in funds focused on sectors and industries, and just about everything in between.
A single ETF or mutual fund can hold hundreds, or even thousands, of individual stocks or bonds. That means both vehicles offer the benefits of diversification in a single trade.
The closer you look at ETFs and mutual funds, the more traits they seem to share at first glance turn out to be significant differences.
Both mutual funds and ETFs are required to disclose their holdings to investors on a regular basis, providing participants line of sight into ongoing performance.
But, the frequency of these communications differs:
Both investment vehicles are generally considered to be liquid assets — that is, they can be easily bought and sold. But how ETFs and mutual funds are traded can impact liquidity.
ETFs have a liquidity edge because they’re priced and traded on an exchange throughout the day, while mutual funds are priced once per day after the market closes. That means investors can buy and sell ETFs at any time during market hours, while mutual fund investors must wait until the end of the day to buy or sell their shares.
But what’s really unique about ETFs — rooted in their unique creation and redemption process — is that two trading markets support their liquidity. In the secondary market, where most investors trade, ETF liquidity is provided by ETFs trading on the exchange. This is enhanced by the primary market liquidity of the ETF’s underlying securities, which can sometimes be even greater than an ETF’s secondary market liquidity.
Note that infrequently traded ETFs could have wide bid/ask spreads, meaning trading costs could be high. Mutual funds always trade without any bid-ask spreads.
Both ETFs and mutual funds are considered cost-efficient investment options that benefit from economies of scale. As a fund grows in size, the costs associated with managing the fund can be spread out over a larger pool of investors.
Indexed ETFs and indexed mutual funds both typically charge management fees and other expenses, but these costs are generally lower than the fees associated with actively managed investments.
But ETFs generally have lower fees, or expense ratios, than mutual funds:
Of course, fees aren’t the only metric to measure costs. It’s important to consider the total cost of ownership (TCO) — the expense ratio plus trading and holding costs — for any investment.
In addition to reducing operating costs, which lowers your fees, the ETF’s unique creation and redemption process also works to reduce TCO. ETFs’ two trading markets provide added liquidity to support the quick reallocation of portfolios or to meet investor redemptions.
This doesn’t mean ETFs are free from expenses. If you buy and sell ETFs regularly, brokerage commissions and other associated trading costs can add up. You’ll find more information about the fees and expenses associated with these investment vehicles in the fund’s prospectus.
Both ETFs and mutual funds are required to distribute capital gains and dividends to investors at least once a year. And those distributions can result in taxable events for investors.
But because ETFs have the ability to use in-kind redemptions to reduce or eliminate capital gains taxes, they distribute fewer capital gains than mutual funds. In 2022, just 3% of fixed income ETFs distributed capital gains compared to 15% of fixed income mutual funds.3 Taking a broad view, 4% of all ETFs distributed capital gains compared to 44% of mutual funds.4
That makes ETFs an inherently more tax-efficient investment vehicle.
Both ETFs and mutual funds provide a diversified investing strategy and offer an easy entry point to a wide range of markets for investors. Interestingly, that entry point, or the minimum investment requirement, may be one of the biggest differences between ETFs and mutual funds.
There is no minimum investment for an ETF. That’s because ETFs can be bought and sold in a single share, making them accessible to investors with smaller amounts to invest. But mutual funds typically require a minimum investment amount, which can range from a few hundred to several thousand dollars.
Understanding the similarities and differences between ETFs and mutual funds can help you choose the right investment vehicle for your portfolio. As you compare traits, deciding between ETFs and mutual funds depends more than anything on your personal investing preferences and your investment goals.
ETFs or Mutual Funds? It Depends on What You Care About
|Transparency||Fund holdings generally made available each day.||Holdings made available monthly or quarterly.|
|Transaction Fee or Commission||Generally subject to a transaction fee.||May be subject to fees when they buy/sell shares.|
|Pricing||Exchange traded; investors can buy and sell shares continuously throughout the trading day at market prices.||Prices do not change intraday; investors can buy and sell shares only at the end of the trading day.|
|Trading Tactics||ETFs have real-time pricing and sophisticated order types that can give you greater control over the price you pay.||Regardless of the time of day you place your order, you'll get the same price as everyone else who bought and sold that day. That price is calculated after the trading day is over.|
|Fees and Expenses||The average expense ratio for index ETFs has historically been lower than that of index mutual funds. ETFs’ average expense ratio is 0.57.5||Mutual funds historically have had a higher average expense ratio. Index mutual funds’ average expense ratio is 0.84.6|
|Tax Consequences When Selling||Investors decide when to sell ETF shares, and any associated capital gains tax is paid at the time of that sale, offering control over taxable gains.||Investors decide when to sell a mutual fund share. To deliver that cash, the fund manager may need to sell a portion of a fund’s holdings, which may generate a realized taxable gain that is absorbed by all fund shareholders.|
|Capital Gains Distributions||Lower capital gains distributions. 4% of all ETFs distributed capital gains compared to 44% of mutual funds.7||Higher capital gains distributions. 4% of all ETFs distributed capital gains compared to 44% of mutual funds.8|
|Investment Amount and Auto||No minimum investments. No automatic investments.||Average minimum investments range from $1,000 to 3,000, higher for institutional shares. Investors can schedule automatic investments.|
1Morningstar Direct. Data as of March 7, 2023. Average Prospectus Net Expense ratio for index ETFs and open end Index mutual funds as defined by Morningstar.
2Morningstar Direct. Data as of March 7, 2023. Average Prospectus Net Expense ratio for index ETFs and open end Index mutual funds as defined by Morningstar.
3Morningstar, as of May 25, 2023. Calculations by SPDR Americas Research. Based on oldest share class.
4Morningstar, as of May 25, 2023. Based on mutual funds of similar Morningstar Category
5Morningstar Direct. Data as of March 7, 2023. Average Prospectus Net Expense ratio for index ETFs and open end Index mutual funds as defined by Morningstar.
6Morningstar Direct. Data as of March 7, 2023. Average Prospectus Net Expense ratio for index ETFs and open end Index mutual funds as defined by Morningstar.
7Morningstar, as of May 25, 2023. Calculations by SPDR Americas Research. Based on oldest share class.
8Morningstar, as of May 25, 2023. Based on mutual funds of similar Morningstar Category.
Creation and Redemption
The process whereby an ETF issuer takes in and disburses baskets of assets in exchange for the issuance or removal of new ETF shares.
The degree to which an asset or security can be bought or sold in the market without affecting the asset’s price. Liquidity is characterized by a high level of trading activity.
The market where shares of an ETF are created or redeemed.
A market where investors purchase or sell securities or assets from or to other investors, rather than from issuing companies themselves. The New York Stock Exchange and the NASDAQ are secondary markets.
Important Risk Information
Frequent trading of ETFs could significantly increase commissions and other costs, such that they may offset any savings from low fees or costs.
These investments may have difficulty in liquidating an investment position without taking a significant discount from current market value, which can be a significant problem with certain lightly traded securities.
Investing involves risk, including the risk of loss of principal.
The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without SSGA’s express written consent.
The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial advisor. All information is from SSGA unless otherwise noted and has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information, and it should not be relied on as such.
Diversification does not ensure a profit or guarantee against loss.
There can be no assurance that a liquid market will be maintained for ETF shares.