How ETFs Differ from Mutual Funds - dummies

By Russell Wild

Part of Exchange-Traded Funds For Dummies Cheat Sheet

At first glance, an exchange-traded fund (ETF) may seem awfully similar to a mutual fund. After all, like ETFs, mutual funds also represent baskets of stocks or bonds. The two, however, are certainly not twins. Maybe not even siblings. Cousins are more like it. Here are some of the significant differences between ETFs and mutual funds:

  • ETFs are bought and sold just like stocks (through a brokerage house, either by phone or online), and their price can change from second to second. Mutual fund orders can be made during the day, but the actual trade doesn’t occur until after the markets close.

  • ETFs tend to represent indexes — entire markets or market segments — and the managers of the ETFs tend to do very little trading of securities in the ETF. (The ETFs are passively managed.)

  • Although they require you to pay small trading fees, ETFs usually wind up costing you much less than a mutual fund because the ongoing management fees are typically much less, and there is never a load (an entrance or exit fee, sometimes an exorbitant one) as there is with some mutual funds.

  • Because of low portfolio turnover and also the way they are structured, investment gains on ETFs usually are taxed more gingerly than the gains on mutual funds.

The following table provides a quick look at some ways that investing in ETFs differs from investing in mutual funds.

ETFs Mutual Funds
Priced, bought, and sold throughout the day? Yes No
Offer some investment diversification? Yes Yes
Is there a minimum investment? No Yes
Purchased through a broker or online brokerage? Yes Yes
Do you pay a fee or commission to make a trade? Often Sometimes
Can you buy/sell
Yes No
Indexed (passively managed)? Typically Atypically
Can you make money or lose money? Yes Yes