Wera Rodsawang | Moment | Getty Images
To the average investor, mutual funds and exchange-traded funds may not seem very different.
After all, they are both relatively liquid baskets of stocks, bonds and other assets overseen by professional money managers, and can help investors diversify their portfolios.
But there are some key differences that may make one a better financial choice than the other for certain investors, according to experts.
How they trade
Perhaps the most obvious difference is how investors trade ETFs and mutual funds.
ETFs trade like stocks: Investors buy or sell them on a stock exchange. By comparison, mutual fund investors transact directly with the fund itself.
While investors can place mutual fund trades during the business day, they won’t know their transaction’s exact price per share until the end of the day. However, ETF investors know their exact purchase price when they transact.
These differences generally matter more for day traders but not the average buy-and-hold investor, said Gloria Garcia Cisneros, a certified financial planner and wealth manager based in Los Angeles, and a member of CNBC’s Financial Advisor Council.
Investors can hurt themselves financially by trading too frequently, experts said.
“Even in a scenario where you’d want to sell intraday, it’s [often] emotion-based and usually not a good way to invest,” said Bryan Armour, director of ETF and passive strategies research for North America at Morningstar.
ETFs are ‘way more tax-efficient’
Taxes and fees are much more consequential differences for everyday investors, experts said.
For example, ETFs can save certain investors from a big year-end tax bill that mutual fund shareholders might otherwise incur.
In this case, the taxes are capital gains, which are taxes owed on investment profits. Fund managers can generate such taxes within a fund when they buy and sell securities. Those capital gains then get passed along to all the fund shareholders, who owe a tax bill even if they reinvest those distributions.
Here’s a look at other stories offering insight on ETFs for investors.
However, ETF investors rarely owe these tax bills: Just 6.5% of U.S. stock ETFs distributed capital gains to investors in 2024, compared to 78% of U.S. stock mutual funds, according to Morningstar.
The trend was similar for international stock funds: About 6% of ETFs distributed capital gains, versus 42% of mutual funds, according to Morningstar.
“Sometimes, [mutual fund investors] get a bit of a nasty surprise in the form of capital gains and a tax bill,” said Lee Baker, a certified financial planner based in Atlanta, and a member of CNBC’s Financial Advisor Council.
While mutual fund managers use cash to buy and sell securities, ETF managers use a different mechanism known as an “in-kind” transaction to facilitate a trade. This basically entails trading securities instead of cash; the method doesn’t trigger a sale, and therefore doesn’t create capital-gains tax.
“ETFs are way more tax-efficient,” Armour said. “That’s a huge advantage over the long term.”
However, there are certain times when ETFs can’t make in-kind transfers, and may therefore create a taxable event: for example, many kinds of derivatives, currency trades and when handling securities from certain international jurisdictions (like India, South Africa and Brazil), Armour said.
Also, ETFs’ tax advantage only exists for investors who hold their funds in a taxable brokerage account. It disappears for those who hold their funds in a tax-sheltered account, like a 401(k) or individual retirement account.
ETFs cheaper ‘in pretty much every way’
Oliver Helbig | Moment | Getty Images
ETFs also tend to be significantly cheaper for investors to own than mutual funds, experts said.
The average asset-weighted investment fee for ETFs was 0.42% in 2024, compared with 0.57% for mutual funds, according to Morningstar.
These fees, known as expense ratios, represent a share of investor assets in a fund. They are charged annually and withdrawn directly from investor accounts.
Some of this fee differential is because a larger share of ETFs are index funds, which tend to be cheaper than actively managed ones, Armour said. It’s therefore natural that mutual funds would be more expensive if a larger share of them is actively managed.
However, many asset managers have debuted identical investment strategies in both an ETF and mutual fund — and, when comparing their fees, the ETFs are still often cheaper for retail investors, Armour said.
He gave the example of the T. Rowe Price Blue Chip Growth fund, which charges a 0.57% annual fee for the ETF version and 0.69% for the investor share class of the mutual fund version.
“In pretty much every way, ETFs are cheaper than mutual funds,” Armour said.
May not have a choice
There may be times when it’s better for investors to buy mutual funds.
For example, the universe of mutual funds is much larger, meaning investors may only be able to access certain funds in a mutual fund structure, experts said.
The ETF universe is expanding, though.
“ETFs are growing in popularity,” Cisneros said. “Even mutual fund managers are launching ETF versions of their strategy.”
Additionally, ETFs aren’t readily available in 401(k) plans, so investors may not have a choice.
Certain brokerages may not allow for dollar-cost averaging into an ETF, Baker said. Investors who want to schedule automatic contributions into a fund on a regular basis may have to choose mutual funds, depending on their brokerage, he said.
Stock News1 week ago
Accounting1 week ago
Stock News1 week ago
Finance1 week ago
