ETF vs Mutual Fund - What's the Difference and Which One Should You Pick?

Investing is not a one size fits all approach.

Some investors prefer a more active approach - that means choosing individual stocks, researching companies, and doing lots of financial analysis.

Other investors like a passive style - where you choose funds and invest on autopilot for the long term.

ETFs and mutual funds are two of the most popular options for passive investors.

These give you exposure to a basket of different stocks all at once, not a single company.

And even if you are an active investor, you can still use ETFs or mutual funds as the base for your portfolio.

But ETFs and mutual funds are not the same - and knowing the key differences will help you choose which ones make the most sense for you.

Let’s break down the differences between an ETF and mutual fund, how to research one, and how to know which one you should pick.

But first: Our CEO Jaspreet Singh is hosting a free live investor workshop in April that breaks down how to spot market shifts and potential investing opportunities.

Click here to register.

First - What Are Funds, and Why Do They Exist?

Before we compare ETFs and mutual funds, it helps to understand what a fund actually is.

A fund is a basket of companies. Instead of going out and buying shares of one company at a time, you buy one share of a fund - and that fund gives you ownership in dozens, hundreds, or even thousands of companies at once.

Think of it like a sampler platter at a restaurant. Instead of ordering one dish and hoping it's good, you get a little bit of everything.

That's what funds do for your portfolio. They spread your money across many companies, which lowers your risk. 

If one company in the fund goes bankrupt, the winners help balance out the losers.

There are three main types of funds investors use - index funds, mutual funds, and ETFs.

Important note: With funds, you can’t really outpace the market or industry that you’re tracking, because you’re investing into the whole thing.

The goal of a fund is not to outpace the industry or market - it’s to match it and offer stability.

This differs with active investing, because researching stocks and knowing when to buy and sell can help you outpace the S&P 500, which is the 500 largest publicly traded companies by market cap.

Each one comes with different options, fees, and use cases - which all matter when you’re trying to build long term wealth.

The Three Differences Between ETFs and Mutual Funds

When it comes to comparing an ETF vs a mutual fund, there are three things you need to understand: Fees, Trading, and Management

Fees

Every fund charges a fee called an expense ratio - the percentage of your investment the fund takes as a management fee each year.

A small fee might seem harmless. But over time, it compounds - just like your investment does.

For example, if you invested $100 a month into the S&P 500 starting at age 21 and did that until you retired, you'd historically have ended up a millionaire. 

But if you had to pay a 1% expense ratio on that investment, your million dollars would shrink to around $750,000.

That's a $250,000 difference from a "small" 1% fee.

So how do ETFs and mutual funds compare on fees?

• ETFs tend to have lower expense ratios, especially passively managed ones. Some of the most popular ETFs charge as little as 0.03% to 0.09% per year.
  
• Mutual funds tend to have higher expense ratios because they're usually actively managed by a person. You can see expense ratios as high as 1% to 2% in some cases.

That doesn't mean mutual funds are a bad deal. But you need to ask - are the returns from this fund worth the higher fee? 

If a fund manager is charging you more, the growth needs to justify it.

Trading

This is where ETFs and mutual funds work very differently.

An ETF - which stands for exchange traded fund - trades just like a stock. You can buy and sell shares of an ETF throughout the trading day, as many times as you want. 

The price changes throughout the day based on supply and demand.

A mutual fund can only be bought or sold once per day, after the market closes. 

The price is set at the end of the trading day based on the fund's net asset value - the total market value of all the shares inside the fund.

For most long-term investors, that might not matter much. 

If you're investing for 10, 20, or 30 years, it doesn't matter much whether you bought at 10:00 AM or 4:00 PM.

But if flexibility matters to you, ETFs give you more control over when and how you trade, you may have to wait a little longer to buy or sell shares.

Management

Index funds and most ETFs are generally passively managed. 

That means a computer runs the show - and the computer follows an algorithm that invests your money into a specific group of companies - like the S&P 500 or the total stock market.

Because you're paying a computer instead of a person, the fees are lower.

Mutual funds are generally actively managed. That means there's a real money manager making decisions about what to buy and sell inside the fund. 

They're trying to find the best companies at the best price.

Because you're paying a human, the fees are higher.

Now, ETFs can also be actively managed - so this isn't a hard rule. But the majority of popular ETFs that everyday investors use are passively managed with low fees.

ETF vs Mutual Fund - Side by Side

How to Research Any Fund Before You Invest

Whether you go with an ETF or a mutual fund, the research process is the same. 

There are three questions you need to answer before you put your money anywhere:

1. Who created the fund?

Start by looking at the fund manager. No, not the individual person, the organization as a whole.

Is it a reputable institution that's been around for decades? Fund managers like Vanguard, Charles Schwab, Fidelity, and SPDR (State Street) are some of the most well-known names in the space.

Why does this matter? Because your money in a fund isn't FDIC insured like a savings account. 

If the economy hits a rough patch, you want your fund managed by a company that's survived downturns before.

2. What's in the fund?

Once you know who runs the fund, you need to then figure out what’s in the fund itself. 

That means knowing what companies you're actually investing in.

Look at the companies inside the fund, how many dollars are under management (look for at least $1 billion for safety), and the asset allocation - how your money is spread across the companies in the fund.

Two funds can track the same thing - like the S&P 500 - but have slightly different weightings. 

SPY and IVV both track the S&P 500, but the percentage each company makes up inside the fund is slightly different.

3. What is the fund costing you?

Check the expense ratio. You should be able to easily find it on the funds webpage. If you can't, that could be a red flag. 

Once you find it, run the math on what that fee will actually cost you over 10, 20, or 40 years. 

A 0.03% expense ratio and a 0.09% expense ratio might look almost identical. But over decades of investing, that difference adds up to real money.

So Which One Should You Pick?

The answer is going to be different for every investor. 

But here's a simple way to think about it:

If you want low fees, flexibility, and a set-it-and-forget-it approach - ETFs are probably the move. Most long-term passive investors gravitate toward ETFs for exactly these reasons.

If you want a professional money manager making investment decisions for you and you're comfortable with higher fees - a mutual fund could be worth it. 

Just make sure you believe the returns will justify the cost.

Remember, you don’t have to choose one or the other - you can actually choose both if you want to.

The overall goal here is to begin investing and start building your wealth. You can do that with an ETF or a mutual fund.

But which one’s specifically? That’s up to you to decide - just make sure you do your research and understand what your goals are before you start investing.

ETFs and mutual funds can become the base for many investors' portfolios. But, if you want to actually outpace the S&P 500, you’ll need to have some cash set aside for active investing.

Our CEO Jaspreet Singh is hosting a free live investor workshop this April where he’ll show you the secret to spotting market shifts and potential investment opportunities.

Want to join? Click here to register (it’s free).