The Office of Investor Education and Advocacy is issuing this Investor Bulletin to help investors understand important similarities and differences between mutual funds and ETFs.

Mutual funds and ETFs are both popular options to help investors save for retirement and other financial goals. While mutual funds and ETFs are similar in some ways, they also have some important differences you should understand before deciding which is best for you. 

Some key similarities between mutual funds and ETFs include:

• SEC registration. Both types of funds are investment companies required to file registration statements with the SEC. Registration provides important protections to investors, including disclosure of key information about a fund in a prospectus. You can obtain a fund’s prospectus from the SEC’s EDGAR database or directly from the fund free of charge (on the fund website or by calling the fund to request a copy).

• Pooled investments. Both types of funds allow multiple investors to pool their money into a single fund that invests in stocks, bonds, other assets, or some combination of these investments. Each fund share represents an investor’s proportionate ownership of the fund’s portfolio—and the gains or losses of the portfolio.
   
• Professional management. Both types of funds are typically managed by SEC-registered investment advisers.
   
• Diversification. Both types of funds can help investors achieve diversification of their investments, spreading their investments across a wide range of companies or industry sectors. This can help lower your risk if one company fails. However, some mutual funds and ETFs are less diverse than others. They may have fewer investments or, in the case of ETFs, even track the performance of a single stock.
   
• Liquidity. Both types of funds are liquid investments. This means their shares can be sold easily and quickly.
   
  • Mutual fund investors can readily sell their shares back to the fund at the next calculated net asset value (NAV) on any business day—minus any fees and charges assessed on redemption.
     
  • ETF investors can sell their shares on the market at any time the market is open at the market price—minus any fees and charges incurred at the time of sale.
• Low minimum investments. Some mutual funds set relatively low dollar amounts to buy shares of the fund. Similarly, ETF shares can often be purchased on the market for relatively low dollar amounts.
   
• Passive or active strategy. Both types of funds can follow either a passive or an active investment strategy.
   
  • A passive strategy seeks to achieve approximately the same return as a particular index. The strategy can be implemented by purchasing all of the securities in the index or a representative sampling. Passively managed funds are typically called index funds.
     
  • An active strategy relies on the skill of an investment manager to create and manage the fund portfolio in line with the fund’s overall investment objective. This means the adviser may buy or sell investments without conforming to an index.
• Fees and expenses. Investors in both types of funds must pay fees and expenses regardless of how the fund performs. Depending on the type of fund, these fees and expenses can include sales charges or brokerage commissions, annual fees, management fees, and other expenses.
   
• Taxes when held in tax-advantaged accounts. While taxes on certain ETFs have historically been lower than those for mutual funds, there is no tax difference between an ETF and a mutual fund if the investment is held in a tax-advantaged account (e.g., a 401(k) or IRA).

Mutual funds and ETFs also differ in some important ways, including:

• How they are bought and sold
  • Mutual funds - Investors buy mutual fund shares from the fund itself, or through a financial intermediary (like a broker). Shares are “redeemable,” meaning that investors can sell shares back to the fund. For some mutual funds, investors purchasing shares can choose from multiple types of shares, or share “classes.” Each share class has a different fee and expense structure.
  • ETFs - Retail investors can buy and sell ETF shares only in market transactions (i.e., on a national stock exchange). That is, unlike mutual funds, ETFs do not sell shares directly to, or redeem their shares directly from, retail investors. 

What this means for you: The way that you buy and sell shares will be different depending on whether you invest in a mutual fund or ETF. While you can hold mutual fund shares directly with the fund, you need a brokerage account to buy, sell, and hold ETF shares. A broker or investment adviser may be able to help you buy and sell both types of funds. In some cases, funds may have an affiliated or in-house broker-dealer or investment adviser with the same name.

• How they are priced
  • Mutual funds – Investors buy or sell mutual fund shares at the NAV per share, plus or minus any applicable fees and charges. NAV is typically calculated at the end of each business day.
  • ETFs – ETFs must also calculate their NAV per share every business day, but retail investors buy and sell ETF shares at market prices, plus or minus any applicable fees and charges. An ETF’s market price may be higher or lower than the ETF’s NAV per share (known as buying or selling at a premium or a discount). An ETF’s market price also fluctuates during the trading day. While an ETF’s market price generally stays close to the ETF’s end-of-day NAV, it may vary significantly.

What this means for you: While you can submit a purchase or sale order for mutual fund shares at any point during the business day, you will not know the exact price per share that you will pay or receive until the end of the business day. You can buy and sell ETF shares on a national stock exchange at the prevailing market price throughout the trading day. You can obtain real-time (or close to real-time) ETF pricing information with relative ease by checking financial websites or by calling a broker.

• How they charge certain fees, for example:
  • Mutual funds – Mutual funds charge some fees indirectly by deducting them from fund assets, such as management fees. When fund fees are paid out of fund assets, the value of the fund decreases and the value of all the investors’ shares decreases. Mutual funds charge other fees directly to investors, such as fees in connection with buying, selling, or exchanging shares, or periodic account fees.
  • ETFs - ETFs also charge some fees, including management fees, indirectly. But ETFs generally do not charge fees directly to investors in connection with the purchase or sale of ETF shares. However, there may be other types of transaction fees and costs, such as commissions paid to a broker in connection with each purchase or sale of ETF shares.

What this means for you: Both mutual funds and ETFs charge you management fees and other fees and expenses. These may be indirect fees, in that they are deducted from fund assets, but you may also pay some direct fees and expenses depending on which fund type you choose. It is always important to consider the total fees and expenses you will be charged in connection with any investment. All fees and expenses reduce the return on your investment.  

• Their relative tax efficiency when held in a taxable account
  • Mutual funds – Mutual fund investors holding shares in a taxable account generally have to pay taxes on any capital gains distributions they receive from the mutual fund.
  • ETFs – ETF investors holding shares in a taxable account may also have to pay taxes on any capital gains distributions from the ETF. However, because many ETFs buy and sell portfolio securities in in-kind exchanges (rather than for cash), they typically have fewer capital gains distributions – and thus lower taxes – than mutual funds.

What this means for you: When you hold mutual fund or ETF shares in a taxable account (e.g., a brokerage account), regardless of which type of fund you are invested in, you may have to pay taxes on capital gains distributions from the fund. However, if you are invested in an ETF, you might pay less in taxes compared to a similar mutual fund because of the way ETFs are structured.

If you’re not sure whether a mutual fund or ETF is best for you, consider consulting your financial professional. Investor.gov also has a variety of materials that can help you understand these products better.

Additional Resources

Mutual Funds

Updated Investor Bulletin: Exchange-Traded Funds (ETFs)

Information Available to Investment Company Shareholders

How to Read a Mutual Fund Prospectus (Part 1 of 3: Investment Objective, Strategies, and Risks)

Investor Bulletin:  Mutual Fund Conversion to Exchange-Traded Fund (ETF)