What is the difference between a mutual fund and an exchange-traded fund (ETF)?

Mutual funds and exchange-traded funds (ETFs) are both popular investment vehicles that pool money from multiple investors to invest in a diversified portfolio of securities. However, there are some key differences between mutual funds and ETFs:

1. Structure: Mutual funds are typically structured as open-ended investment companies. This means that the fund company issues new shares to investors at the net asset value (NAV) and redeems shares at the same NAV. Mutual funds are bought and sold directly through the fund company at the end-of-day NAV price. In contrast, ETFs are structured as investment trusts or exchange-traded products. ETF shares are traded on stock exchanges like individual stocks throughout the trading day, and their prices fluctuate based on supply and demand. ETFs can be bought and sold at market prices, which may differ from the underlying net asset value.
2. Trading: Mutual fund transactions are executed at the end of the trading day after the market closes, at the fund’s net asset value per share. Investors in mutual funds can buy or sell shares at the NAV price determined by the fund’s valuation at the end of the day. On the other hand, ETFs trade intra-day on stock exchanges like individual stocks, allowing investors to buy or sell ETF shares at market prices throughout the trading day. This provides more flexibility for investors to enter or exit positions at any time during market hours.
3. Cost Structure: Mutual funds often have expense ratios, which include management fees and other operating expenses. These expenses are deducted from the fund’s assets and reduce the investor’s overall return. Mutual funds may also charge sales loads, which are fees paid when buying or selling shares. ETFs generally have lower expense ratios compared to actively managed mutual funds, and they typically do not have sales loads. However, investors trading ETFs may incur brokerage commissions and bid-ask spreads.
4. Portfolio Management: Mutual funds can be actively managed or passively managed (index funds). In actively managed mutual funds, professional fund managers aim to outperform the market by actively selecting and managing the fund’s investments. Index mutual funds aim to replicate the performance of a specific market index. ETFs can be structured as either actively managed or passively managed funds as well. However, ETFs are more commonly associated with passive management, tracking specific indexes and providing broad market exposure.
5. Tax Efficiency: ETFs generally have a more tax-efficient structure compared to mutual funds. Since ETFs are traded on an exchange, investors can buy and sell shares without triggering capital gains taxes for other ETF holders. Additionally, ETFs have a unique creation and redemption process that allows them to distribute capital gains in-kind, which helps minimize taxable events. In contrast, mutual funds may distribute capital gains to all shareholders when the fund manager sells securities at a profit, potentially resulting in taxable events for investors.
6. Investment Options: Mutual funds offer a wide range of investment options, including equity funds, bond funds, money market funds, and sector-specific funds. ETFs also cover a broad range of asset classes and investment strategies, including equity ETFs, bond ETFs, commodity ETFs, and international ETFs.

Both mutual funds and ETFs have their own advantages and disadvantages, and the choice between the two depends on an investor’s specific needs, preferences, and investment goals. It’s important for investors to carefully consider these factors and conduct thorough research before investing in any fund