United States: Mutual Funds Or ETFS? Understand The Differences Before You Choose

Last Updated: August 17 2016
Article by Dan Newman

Mutual funds have been around for nearly a century. Exchange-traded funds, or ETFs, are the newer kid on the block. The two investment types have much in common, but also have important differences that make each more appropriate for certain situations.

Passive or Active

ETFs have quickly assumed a prominent place on the U.S. investment landscape. In late 2014, more than $2 trillion in net assets were held in 1,400 ETFs, up from a single offering in 1993 and fewer than 100 in 2002. Despite this growth, mutual funds remain dominant. According to the Investment Company Institute, there are nearly $16 trillion of assets owned across about 8,000 mutual funds.

There are two basic types of mutual funds: actively managed and index-based. With actively managed funds, a portfolio manager decides which securities to buy and sell to give the fund the best opportunity to outperform a benchmark index. Index funds, however, are passively managed, meaning they are designed to replicate a benchmark's characteristics and match its performance.

Despite a small number of actively managed ETFs, the vast majority are passive investments. They are designed to track a particular benchmark, making them most similar to index mutual funds.

Differences in Pricing

Even though index funds and ETFs share many characteristics, they also have significant differences. For starters, investors in mutual funds generally buy and sell shares directly from a fund company. The shares are priced once per trading day after the close of trading and investors must buy before then to receive that day's price.

ETF shares, in contrast, are transacted on stock exchanges via a brokerage account. Their prices fluctuate throughout the day based on supply and demand. This means that shares sometimes temporarily trade at a premium or discount to their underlying investment's net asset value (NAV). If the gap between share price and NAV gets too wide, buyers or sellers theoretically emerge to bring the prices back in line. However, in practice, the price discrepancy can persist for days or even longer.

Another key difference is that, just as with stock trades, investors incur brokerage commissions each time they buy and sell ETFs. Thus, the more frequently you transact, the higher your cost of ownership. Buying mutual fund shares directly from a fund company is usually commission-free (although some funds do have sales charges or "loads").

Because most ETFs are passively managed, they tend to have low expenses, especially compared with actively managed mutual funds. Index mutual funds also generally have low expenses.

Tax Treatment Varies

Most ETFs are tax efficient, especially compared to actively managed mutual funds, because they are not required to make distributions. ETFs are also typically more tax efficient than index mutual funds.

When index funds need to redeem shares, portfolio managers may have to sell stock to generate cash. This can create capital gains that are passed through to individual shareholders, even those who never sell their own fund holdings. Because ETFs are transacted privately between buyers and sellers, investors have significantly more control over their taxes.

However, it is important to note that, if you own mutual funds in a tax-advantaged retirement account, such as an IRA, your purchases and sales do not involve capital gains. Further, fund distributions do not result in tax.

Consider Your Goals

Both mutual funds and ETFs can help you achieve your investment objectives. However, both also carry risks, including the risk that they will decline in value and you will lose money that you have invested in them. Discuss your goals and risk tolerance with your financial advisor and he or she can help guide you on the most appropriate investment.

Sidebar: Consider Your Objectives

Your individual situation will determine whether you are best suited for an exchange-traded fund (ETF) or a traditional mutual fund.

If you want a chance to beat the market (by, for example, outperforming the S&P 500 index), you will probably want to consider an actively managed mutual fund. Of course, despite their best intentions, many active managers wind up trailing their benchmark because of higher expenses and other factors.

It is important to think about your investment goals and timing. If you plan to make small, regular investments for a long-term objective, you might be better off setting up an automatic investment plan with a mutual fund company. That way, your frequent purchases will be free of transaction costs. ETFs, meanwhile, may be more cost effective if you are making a larger, one-time investment.

Consider the investment objectives, risks and charges and expenses of mutual funds carefully before investing. For this and other information about the mutual funds you are considering, please read the prospectus carefully before investing. Mutual fund investment values will fluctuate and shares, when redeemed, may be worth more or less than original cost.

ETFs do not sell individual shares directly to investors and only issue their shares in large blocks. ETFs are subject to risks similar to those of stocks. Consider the investment objectives, risks and charges and expenses of ETFs carefully before investing. Investment returns will fluctuate and are subject to market volatility, so that an investor's shares, when redeemed or sold, may be worth more or less than their original cost.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Dan Newman
Similar Articles
Relevancy Powered by MondaqAI
Milbank, Tweed, Hadley & McCloy LLP
Cadwalader, Wickersham & Taft LLP
Carlton Fields
In association with
Related Topics
Similar Articles
Relevancy Powered by MondaqAI
Milbank, Tweed, Hadley & McCloy LLP
Cadwalader, Wickersham & Taft LLP
Carlton Fields
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions