ETFs vs. mutual funds: Understand the difference
E*TRADE from Morgan Stanley
Summary: ETFs and mutual funds allow you to own a small portion of many different investments. Here’s what you need to know to choose between them and how they might help you reach your financial goals.
Exchange-traded funds (ETFs) and mutual funds are popular investments with some similar characteristics: they’re both relatively low-cost ways to achieve portfolio diversification. But they also have some important differences.
How they are similar
Both ETFs and mutual funds…
- Are collections or “baskets” of individual stocks, bonds, or other investments—in some cases hundreds of them—pooled together. When you buy a share of the fund, you own a small piece of this big basket of assets.
- Give you a very broad range of investment choices. Among the thousands of ETFs and mutual funds on the market, you can find funds that buy different types of investments (stocks, bonds, and others) or invest in different geographic locations, industries, types and sizes of companies, and much more.
- Are typically less risky than buying individual stocks and bonds. Because ETFs and mutual funds can hold so many different individual investments, one poorly performing asset will have a smaller impact on your overall portfolio. In other words, ETFs and mutual funds typically give you some diversification.
- Have professional managers who pick the investments, so you don't have to select them. Professional portfolio managers choose and monitor stocks, bonds, and/or other investments that are in the fund, using either active or passive management strategies.
How they're different
| ETFs | Mutual Funds | |
|---|---|---|
| How it trades | You can buy and sell shares directly on major stock exchanges throughout the day. | Mutual funds trade once a day, after the market closes. You can place a buy or sell order at any time, but the order executes at the end of the day. The final price you pay for the shares reflects the price of the share at closing.1 |
| How much are you required to invest? | You can buy as little as one share of an ETF, meaning it’s often less expensive to get into an ETF than into a mutual fund. |
Mutual funds usually require a minimum investment dollar amount. You receive a number of shares based on your investment and the share price. |
Investment style: Active or passive? |
Many ETFs tend to be passively managed index funds, meaning they aim to mirror the performance of a market index before expenses. Some are actively managed. |
Many mutual funds are actively managed, meaning professional fund managers draw on their expertise to try to outperform the average returns of a market or index. Some are passively managed. |
| Expenses you pay | Management and other fees (known as the expense ratio). This fee is included in the value of the fund and disclosed in the prospectus. |
In general, actively managed funds tend to have higher expense ratios than index funds. |
| Other things to know | Like stocks, you can use limit and stop orders to trade ETFs, as well as trade them on margin, use them in certain options trades, and sell short. |
It’s easier to use mutual funds for automatic investing (where you invest a pre-determined amount at regular intervals, say $100 every month.) |
In general, those with a smaller budget for investing and who want to make frequent trades might benefit from investing in ETFs, while those with a larger budget who like to automate their investments might prefer mutual funds.
Choosing the best investment for you
The right investment for your portfolio will depend on several factors, including:
- your financial goals,
- the amount you’re able to invest, and
- whether you prefer to trade frequently or to automate your strategy.
In general, those with a smaller budget for investing and who want to make frequent trades might benefit from investing in ETFs, while those with a larger budget who like to automate their investments might prefer a mutual funds.
CRC# 3780369 11/2024
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