ETFs vs. Mutual Funds: A Side-By-Side Comparison

What’s the difference: ETF vs mutual funds? Exchange-traded funds and mutual funds are two avenues chosen by some investors to pursue diversification. Learn more here.

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Key Takeaways

  • Mutual Funds and Exchange-traded funds (ETFs) are two investment vehicles used by investors to pursue diversification
  • Though the two fund types share many traits, there are differences
  • Learn the characteristics of each type and compare to your investment objectives to decide which is right for you

If you’re like many investors saving for retirement or another goal, you’ve heard about portfolio diversification. “Don’t put all your eggs in one basket” is among the most common pieces of wisdom dispensed to investors.

Two typical avenues investors might use for diversification are mutual funds and exchange-traded funds (ETFs). When making a comparison of ETFs vs. mutual funds, it's important to note that ETFs and mutual funds are similar in that both represent a professionally managed “basket” of securities, typically stocks and bonds. Yet they're structured differently.

Most, though not all ETFs feature a "passive" management approach and most, though not all mutual funds feature an "active" management approach; the expense ratios respective to both instruments may also vary; and the features and functionalities that make either instrument a good match for an individual investor is contingent upon the investor’s financial goals, resources and individual investing preferences. 

For investors trying to decide whether mutual funds or ETFs are the right choice, it helps to delve a bit deeper in how they compare and contrast. First, let's look at the landscape, which has changed dramatically over the last 25 years.

ETFs Seeing Inflows, but Still Dwarf Assets Held in Mutual Funds 

An ETF is a single security that typically tracks an index or portfolio, or seeks to target their performance. ETFs burst onto the financial scene in 1993. Over the last decade, there's been a tremendous rise in the number of ETF products, as well as the amount of assets held in ETFs. More employers now offer access to them as part of their retirement packages along with mutual funds, and retail investors trade them with increasing regularity. Many financial pundits tout their functionalities as if these products somehow constituted an “evolutionary” step in the fund space.

According to data compiled by the Investment Company Institute (ICI), the number of distinct ETF product offerings nearly tripled from 2007 to 2016. In that same period, inflows for ETFs increased from $600 billion to $2.5 trillion. Mutual fund investments had been growing steadily through the decades, but lately have experienced outflows. In terms of total assets held, however, mutual funds still dominate the landscape. According to the ICI's 2017 Handbook, U.S. investors held $16.34 trillion in mutual funds as of the end of 2016. 

Let’s Compare

Let’s start with a basic comparison. Take a look at the table below.

FeatureMutual FundsETFs
Diversified offerings, including the chance to expose your portfolio to a variety of sectors, such as value, growth, or international holdings
YesYes
Offers a more passive managing approach and potentially lower expense ratios.
Sometimes, depending on the fundMost of the time
Gives a daily update of all the shares or other investments held by the fund.
NoYes
Managed by professionals.
YesYes
Same order types available as for individual stocks.
NoYes
Tracks minute-by-minute trades as the market moves.
NoYes
Net asset value determined by the total value of the underlying assets, minus fees, divided by the total number of shares.
YesYes

So, what might these features (or lack thereof) mean for you as an investor? In other words, what could they help you accomplish, and what demands or limitations might they place on you as an individual investor?

To answer these questions, here’s a brief summary of some of the pros and cons of exchange-traded funds vs. mutual funds.

Potential Pros of Owning ETFs

With ETFs, you can trade more flexibly, as these products are traded intraday. Your minimum investment requirements are generally lower than mutual funds. Daily holding disclosures make ETF investing more transparent. And finally, unless you're invested in mutual funds through an IRA plan, ETFs might be more tax efficient, as you're generally required to pay taxes only on closed positions that realize capital gains, whereas (non-IRA) mutual fund holders may be subject to taxable events when fund managers realize gains in the course of rebalancing a portfolio by turning over assets. A 2016 study by S&P Dow Jones Indices found that over the past 15 years, 92.15% of large-cap managers, 95.4% of mid-cap managers, and 93.21% of small-cap managers trailed their respective benchmarks. Some might conclude, then, that a "passive" investing model that invests in funds that target an index might be an appropriate strategy.

ETF Cons

Although ETFs are professionally managed, they do not offer the same level of “active management” as mutual funds. As a self-directed ETF investor, you might need to take a more active role in monitoring, reviewing and potentially rebalancing your portfolio. This self-directed approach might require additional time and effort. Also, if you plan to actively trade the assets in your account, or if you plan to make incremental additions to your ETF holdings, remember that multiple trades can mean multiple transaction costs.  

If you prefer to invest in a fund that offers a more hands-on approach to allocating and rebalancing your assets in light of longer-term economic opportunities and risks, then you might want to take a closer look at a service that allocates and rebalances a portfolio of ETFs for you, such as Essential Portfolios, from TD Ameritrade Investment Management, LLC.*

Mutual Fund Pros

With mutual funds, you have the option of investing in passively managed and actively managed funds. Passive funds are similar to most ETFs in that they track a specific benchmark such as the S&P 500 index. But only through mutual funds can you benefit from a professional fund manager’s efforts in actively balancing and rebalancing your portfolio in response to big-picture economic fundamentals. This in itself is a major advantage offered by mutual funds; one that is largely absent in ETFs and one that may be highly suitable to investors who prefer a more hands-off approach to investing.

Good fund managers know the “ins and outs” of portfolio construction. They understand the intricacies of particular sectors in relation to the wider economic landscape, and they’re seasoned market participants who probably have weathered several market downturns and other unfavorable economic conditions in pursuit of overlooked and undervalued assets. Although mutual funds might not have the “intraday” trading convenience of an ETF, as funds are purchased or “redeemed” end-of-day (EOD) either directly through the fund’s issuing company or through a broker, mutual funds nevertheless offer the convenience of direct automatic deposits; a feature that ETFs do not offer.

Mutual Fund Cons

Some mutual funds have high asset turnovers, which can mean more transaction costs and a larger capital gains tax bill. Fund managers report their holdings quarterly or semiannually; this means that you won’t always know the details or frequency of each transaction. And finally, mutual fund holders may also be required to pay 12b-1 fees: annual marketing and distribution fees that are part of a fund’s operating expenses. Bear in mind that these “expense ratios” are characteristic of both products, mutual funds and ETFs. And some mutual funds may come with higher or lower expense ratios than other funds or ETFs. So be sure to read a fund’s prospectus carefully to determine whether its strategy and costs may be suitable to your investment goals.

Yet Mutual Funds and ETFs Have Similarities

  • Both provide a cost-effective means for you to invest in pooled assets.
  • Both offer an easy way to pursue diversification.
  • Both can be traded without transaction costs, via either "no transaction fee" mutual funds or "commission-free" ETFs, including commission-free ETFs offered by TD Ameritrade.

In short, both products come with their own set of advantages and disadvantages.

But which product—mutual funds or ETFs—might better serve your financial goals, match your risk tolerance, or align with your investment style? Ultimately, it depends on the kind of investor you are.

How actively do you plan to invest? How much time are you willing to spend on monitoring your portfolio? How much effort do you want to put into enhancing your investing acumen? Let these answers guide you as you compare ETFs vs. mutual funds.

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Carefully consider the investment objectives, risks, charges, and expenses before investing. A prospectus, obtained by calling 800-669-3900, contains this and other important information about an investment company. Read carefully before investing.

*Advisory services are provided by TD Ameritrade Investment Management, LLC (“TD Ameritrade Investment Management”), a registered investment advisor. Brokerage services provided by TD Ameritrade, Inc. TD Ameritrade Investment Management provides discretionary advisory services for a fee. Risks applicable to any portfolio are those associated with its underlying securities. For more information, please see the Disclosure Brochure (Form ADV Part 2A) http://www.tdameritrade.com/forms/TDA4855.pdf

Mutual funds are subject to market, exchange rate, political, credit, interest rate, and prepayment risks, which vary depending on the type of mutual fund.

Diversification does not eliminate the risk of experiencing investment losses.

ETFs can entail risks similar to direct stock ownership, including market, sector, or industry risks. Some ETFs may involve international risk, currency risk, commodity risk, and interest rate risk. Trading prices may not reflect the net asset value of the underlying securities. Commission fees typically apply.

Particular commission-free ETFs may not be appropriate investments for all investors, and there may be other ETFs or investment options available at TD Ameritrade that are more suitable. 

ETFs purchased commission-free that are available on the TD Ameritrade ETF Market Center are available generally without commissions when placed online in a TD Ameritrade account. Other fees may apply for trade orders placed through a broker or by automated phone. 

TD Ameritrade receives remuneration from certain ETFs that participate in the commission-free ETF program for shareholder, administrative and/or other services.

No Margin for 30 Days.  Certain ETFs purchased commission free that are available on the TD Ameritrade ETF Market Center will not be immediately marginable at TD Ameritrade through the first 30 days from settlement. For the purposes of calculation the day of settlement is considered Day 1.  

Short-Term Trading Fee (Holding Period for 30 Days).  ETFs available commission-free that participate in the ETF Market Center may be subject to a holding period that commences with any purchase and extends through the following THIRTY (30) calendar days.  An account owner must hold all shares of an ETF position purchased for a minimum of THIRTY (30) calendar days without selling to avoid a short–term trading fee where applicable.  There is no limit to the number of purchases that can be effected in the holding period. Any order to sell within THIRTY (30) calendar days of last purchase (LIFO – Last In, First Out) will cause an account owner's account to be assessed a short–term trading fee of $13.90 where applicable. For the purposes of calculation the day of purchase is considered Day 0. Day 1 begins the day after the date of purchase.  The short–term trading fee may be applicable to each purchase of each ETF where such ETF is sold during the holding period. The short–term trading fee may be more than applicable standard commissions on purchases and sells of ETFs that are not commission-free. 

TD Ameritrade does not provide tax advice. Clients should consult with a tax advisor with regard to their specific tax circumstances.

TD Ameritrade and all third parties mentioned are separate and unaffiliated companies, and are not responsible for each other’s policies or services.

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Market volatility, volume, and system availability may delay account access and trade executions.

Past performance of a security or strategy does not guarantee future results or success.

Options are not suitable for all investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial losses. Options trading subject to TD Ameritrade review and approval. Please read Characteristics and Risks of Standardized Options before investing in options.

Supporting documentation for any claims, comparisons, statistics, or other technical data will be supplied upon request.

The information is not intended to be investment advice or construed as a recommendation or endorsement of any particular investment or investment strategy, and is for illustrative purposes only. Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.

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