What is a mutual fund and how is it different from an ETF

Investing can feel overwhelming, whether you’re just starting out or seeking new ways to grow your wealth. Two of the most popular vehicles—mutual funds and ETFs—offer diversification and professional oversight, but they function quite differently. In this article, we’ll unpack each one, compare their mechanics, and offer practical guidance to help you decide which fits your strategy.

What is a Mutual Fund?

A mutual fund is an investment vehicle that pools money from multiple investors to assemble a diversified portfolio of stocks, bonds or other securities. Each investor owns shares that entitle them to a proportional claim on the fund’s assets and earnings.

Most mutual funds are professionally managed by fund managers who buy and sell securities according to the fund’s stated objectives. You can choose from actively managed funds aiming to outperform benchmarks or passive funds that track indexes like the S&P 500.

How Mutual Funds Work

Mutual funds are typically structured as open-end funds meaning the fund issues and redeems shares at its Net Asset Value (NAV). NAV is calculated at the end of each trading day by dividing the fund’s total assets minus liabilities by the number of shares outstanding.

When you invest, you purchase shares directly from the fund at that day’s NAV. If you redeem, the fund buys back your shares at the end-of-day NAV. Returns comprise dividends, interest, and capital gains distributions, which you can either reinvest or receive as cash.

Fees include management fees, administrative costs, and sometimes sales loads. These charges reduce net returns, so it’s important to review the fund’s expense ratio before investing.

Key Statistics and Historical Growth

Mutual funds have become a cornerstone of American investing. As of the mid-2020s, about 53% of U.S. households held mutual funds—up from just 6% in 1980. Even Gen Z families represent 35% of investors in mutual funds.

By the end of 2019, U.S. open-end mutual funds managed over $21.3 trillion, accounting for 83% of the domestic funds industry. This growth reflects the appeal of professional management and broad diversification for individual investors.

What is an ETF?

An Exchange-Traded Fund (ETF) also pools investors’ capital to buy a diversified set of assets, but it trades on an exchange like a stock. ETFs can track indexes, sectors, commodities, or actively managed strategies.

Unlike mutual funds, ETFs offer intraday trading flexibility and liquidity, meaning you can buy or sell shares throughout the trading day at market-driven prices. These prices can trade at a premium or discount to the fund’s NAV.

ETFs generally have lower expense ratios and, due to their unique structure, often deliver >20% better after-tax performance compared to similar mutual funds in taxable accounts.

Core Differences Between Mutual Funds and ETFs

While both vehicles grant access to a diversified portfolio, key distinctions can sway your investment decision. Below is a summary of the primary differences:

Diversification Benefits

Both mutual funds and ETFs offer instant diversification, reducing the risk of individual security exposure. Key advantages include:

• Exposure to a broad range of assets with one purchase
• Professional oversight to manage asset allocation and rebalancing
• Access to markets and sectors that may be difficult to reach directly

Fund Management and Regulation

Mutual funds and ETFs are registered investment companies, regulated by the SEC in the U.S. All holding disclosures, performance reports, and fee structures are publicly available.

Major fund families like Vanguard, Fidelity, and BlackRock offer both mutual funds and ETFs, applying stringent governance standards to safeguard investors’ interests.

Suitability for Different Investors

Choosing between a mutual fund and an ETF often depends on your investing style:

• Long-term, passive investors who want automatic reinvestment of dividends may favor mutual funds.

• Active traders, or those seeking intraday price control and low expense ratios and fees, typically lean toward ETFs.

Tax Implications

Mutual funds frequently distribute capital gains, which can trigger tax liabilities in taxable accounts. ETFs, by contrast, use an in-kind creation redemption process that helps minimize taxable events, offering greater tax efficiency for buy-and-hold investors.

Practical Tips for Buying and Selling

To invest in mutual funds, open an account with a mutual fund company or brokerage, meet the minimum purchase, and place a buy or sell order before market close.

For ETFs, you need a brokerage account. You can place market or limit orders during trading hours, just like stocks. Watch bid-ask spreads and volume to ensure cost-effective trades.

Choosing the right investment vehicle often involves weighing your time horizon, tax situation, trading preferences, and cost sensitivity. By understanding how mutual funds and ETFs operate—and where they differ—you can build a portfolio that aligns with your financial goals and risk tolerance.

Whether you opt for the end-of-day simplicity of mutual funds or the real-time flexibility of ETFs, both paths can lead to a well-diversified and professionally managed portfolio. With knowledge as your guide, you can navigate the financial markets with confidence and purpose.