Both mutual funds and ETFs can help you build a diversified portfolio, but they differ in structure, trading, costs, taxes, and management style. Understanding these differences helps you make confident, informed decisions and align your investments with your goals, timeline, and account type. Here’s what to remember:
- Trading & flexibility: ETFs trade like stocks during the day, giving intraday control. Mutual funds trade once daily, which simplifies long-term investing.
- Costs: As of 2025, index ETFs cost investors about 0.16% on average, compared with roughly 0.42% for mutual funds, based on data from ICI and Morningstar. Some of the lowest-cost index funds charge just 0.02% to 0.05% in annual fees. Small differences in cost can compound significantly over time.
- Taxes: ETFs are more tax-efficient in taxable accounts due to in-kind redemptions, while mutual funds may generate capital gains annually.
- Management options: Both offer active and passive strategies, but active mutual funds are more common and can be costlier; index ETFs are a low-cost, flexible way to track market benchmarks.
- Minimum investments: Most mutual funds still require an initial minimum between $250 and $3,000, though many brokerages waive this for IRAs or automatic investing plans. ETFs only require the price of a share, with fractional shares making dollar-based investing easy.
Mutual funds vs. ETFs
When it comes to retirement planning, the choice between mutual funds and ETFs doesn’t have to feel intimidating. Both let you invest in a diversified basket of stocks or bonds, but they operate differently, and those differences can influence costs, taxes, and how easily you trade.
There’s no single “right” choice. Many investors blend both, leveraging the benefits of each to build a portfolio that aligns with their goals. With thoughtful guidance, you can create a strategy that balances flexibility, efficiency, and long-term growth, making your retirement plan stronger and more tailored to your unique financial situation.
What are mutual funds and ETFs?
Mutual funds and ETFs are both ways to invest in a diversified portfolio without having to pick individual stocks or bonds yourself. Think of them as professionally managed baskets of investments. The main difference comes down to how they’re structured and traded.
Exchange-Traded Funds (ETFs) 101
ETFs function like stocks, but each share represents a bundle of investments: stocks, bonds, or other assets. You buy and sell them through a brokerage account during market hours, with prices moving throughout the day based on supply and demand. Most ETFs track an index, aiming to match the performance of benchmarks like the S&P 500.
A unique feature of ETFs is their creation and redemption process. Large institutional investors can create or redeem shares directly with the fund company, which keeps the ETF’s market price aligned with the value of its underlying assets. This process also contributes to their tax efficiency, making ETFs especially attractive in taxable accounts.
Mutual funds 101
Mutual funds pool money from investors to purchase a portfolio of securities according to a clearly defined strategy. When you invest in a mutual fund, you’re buying shares of the fund itself, not the individual investments it holds.
Professional fund managers decide which securities to buy or sell, aiming to meet the fund’s objectives. Some funds are actively managed, seeking to outperform the market, while others passively track an index. Minimum investments usually range from $500 to $3,000, though many retirement-focused funds have no minimum.
How they trade and what you pay
How mutual funds and ETFs are bought and sold affects your investing experience more than you might think. These differences shape when you can trade, what price you pay, and how much control you have over your transactions.
ETFs
ETFs trade on stock exchanges just like individual stocks, giving you the ability to buy or sell anytime during market hours: 9:30 AM to 4:00 PM Eastern Time. This intraday trading lets you control your entry and exit points precisely. You can place limit orders to lock in a specific price or use stop-loss orders to help manage risk.
Liquidity is maintained by market makers, who continuously buy and sell shares, keeping bid-ask spreads tight for popular ETFs. Real-time pricing means you can react immediately to news or market events. This flexibility is particularly valuable if you’re an active trader or want the ability to make tactical adjustments in your portfolio.
Mutual funds
Mutual funds, in contrast, are priced once per day after the market closes at 4:00 PM Eastern Time. This net asset value (NAV) reflects the total value of all fund holdings divided by the number of shares outstanding. When you place an order during the day, your transaction executes at that evening’s NAV.
This approach removes the temptation to try and “time the market” throughout the day. For long-term investors, this can be a benefit. It encourages disciplined, regular investing—especially if you’re contributing on a set schedule—without the distraction of intraday price swings.
Costs and minimum investments
This illustration is hypothetical and for informational purposes only. It assumes a one-time investment compounded annually over 30 years, using the same gross annual return for both portfolios. The “Low-Cost Index ETF” example reflects an annual expense ratio of 0.03%. The “1% AUM Portfolio” reflects the same investment return reduced by a 1% annual advisory fee. Returns are shown before taxes and are not guaranteed. Actual performance will vary based on market conditions, investment selection, fees, and other factors. Past performance is not indicative of future results.
Fees and minimums might not be the most exciting part of investing, but they can make a big difference in your long-term returns. A Domain Money financial advisor can guide you in selecting the right funds for your goals while keeping costs and minimums in check.
Mutual funds
When you invest in mutual funds, understanding fees and minimums is key to maximizing your long-term returns. Expense ratios cover the fund’s operating costs, and they can vary widely. Low-cost options like Vanguard’s Admiral Shares VFIAX charge just 0.04% annually, while actively managed funds average around 0.70%. Over decades, even small differences in fees can compound into thousands of dollars in lost potential growth.
Most mutual funds require a minimum initial investment, usually between $1,000 and $3,000. Some funds waive these minimums for retirement accounts or automatic investment plans. Once you’ve met the minimum, you can invest any dollar amount and even buy fractional shares. This makes it easy to put your entire monthly contribution to work immediately, without leaving cash uninvested.
ETFs
ETFs are often even more cost-efficient than mutual funds. Many broad-market ETFs, like Vanguard’s VTI and VOO, carry expense ratios of just 0.03%, while SPDR’s SPLG charges only 0.02%. These low costs help you keep more of your money invested over the long term, letting compounding work its magic.
ETFs don’t have formal minimum investments beyond the price of a single share, which can range from $20 to $500. With fractional shares now widely available through most brokers, you can invest exact dollar amounts, so every dollar you plan to contribute is actually at work in your portfolio.
Taxes and tax efficiency
Taxes can quietly erode your investment returns, especially in taxable accounts. Understanding how mutual funds and ETFs generate taxable events, and which accounts you hold them in, can help you keep more of your money working for you.
Mutual funds
When you invest in a mutual fund, the fund may distribute capital gains whenever the managers sell securities for a profit. These distributions usually occur once a year, and you’ll owe taxes on them even if you didn’t sell any shares yourself. Whether you reinvest these distributions or take them as cash, they create taxable events that can chip away at your returns over time.
Mutual funds are actively managed, which can mean more frequent trading within the fund. While this can help the fund achieve its investment objectives, it can also result in higher capital gains distributions compared with passively managed options.
Being aware of these tax implications helps you plan which accounts to hold mutual funds in—retirement accounts like IRAs or 401(k)s often shield you from these taxes.
ETFs
ETFs are structured differently, which often makes them more tax efficient. When investors sell ETF shares, they’re trading on the exchange with other investors, not redeeming shares directly with the fund company. This process, known as in-kind redemption, allows ETFs to manage redemptions without triggering capital gains for remaining shareholders.
For long-term investors, this structure can significantly reduce taxable events, especially in taxable brokerage accounts. Popular options include broad-market ETFs like Vanguard’s VTI for U.S. exposure or VXUS for international stocks. Adding municipal bond ETFs like VTEB or iShares MUB can further minimize taxes.
Domain Money’s CFP® professionals can also help implement strategies like tax-loss harvesting and asset location to optimize your after-tax returns.
Management and investment strategy
How your investments are managed has a direct impact on costs, returns, and your overall experience as an investor. Whether you prefer a hands-off approach that mirrors the market or a more active strategy aiming to outperform it, understanding the differences helps you choose investments that fit your goals, risk tolerance, and retirement timeline.
Mutual funds
Mutual funds offer both active and passive management options. Index mutual funds track benchmarks like the S&P 500 or the total stock market, giving you diversified exposure at low costs. Popular options include Vanguard’s VTSAX or Fidelity’s FXAIX. They’re particularly convenient for retirement accounts, where automatic contributions and dividend reinvestment keep your savings growing without constant attention. The small tax inefficiencies compared to ETFs are often irrelevant inside tax-advantaged accounts.
Actively managed mutual funds take a different approach. Fund managers research, select, and time trades with the goal of outperforming a benchmark index. While this can lead to higher potential returns, it also comes with higher costs. On average, about 0.70% annually compared to 0.05% for index funds.
Keep in mind that over the long term, most active managers struggle to beat the market after fees and taxes. That said, active management can be worthwhile in specialized areas like small-cap or emerging market funds, where skilled managers may add real value.
ETFs
ETFs also provide both active and passive strategies. Index ETFs track market benchmarks just like index mutual funds, but with the added flexibility of intraday trading. This makes them ideal if you want to react to market changes or take advantage of short-term opportunities, while still keeping costs extremely low. Many broad-market ETFs have expense ratios under 0.05%.
Actively managed ETFs now represent roughly 8–10% of ETF assets and continue to grow, combining professional management with the structural tax efficiency of ETFs. They follow the same principle as mutual funds, but with the potential benefits of ETF structure: intraday trading and greater tax efficiency. Active ETFs can be useful if you want professional management but still value liquidity and tax-conscious investing in a taxable account.
Choosing the right fund for your financial goals
When considering mutual funds vs. ETFs, each has its advantages: ETFs deliver low costs and tax efficiency in taxable accounts, while mutual funds provide automation and simplicity for retirement savings. The right choice depends on your goals, account types, and investing style.
Review your portfolio and think about where each fund fits best. ETFs can help minimize taxes, and mutual funds make regular contributions effortless. Domain Money’s flat-fee CFP® professional team can guide you in creating a strategy that balances both for your unique situation.
Focus on low fees, broad diversification, and long-term discipline—the best investment is the one you’re confident enough to hold through market cycles.
Ready to optimize your approach to mutual funds vs. ETFs? Connect with a CFP® professional at Domain Money for a free strategy session to discuss your goals.
Frequently Asked Questions (FAQs):
Which is better, an ETF or a mutual fund?
Neither is inherently “better,” it depends on your goals, account type, and investing style. ETFs tend to offer lower costs and tax efficiency, making them great for taxable accounts. Mutual funds provide simplicity and automated investing, which works well in retirement accounts. Often, a balanced portfolio will include both.
Why would someone choose a mutual fund over an ETF?
Mutual funds are ideal if you value automatic contributions, dividend reinvestment, or investing without worrying about intraday price swings. They’re particularly convenient in 401(k)s or IRAs, where regular, automated investing can help you build wealth steadily.
What is the 7/5/3-1 rule in mutual funds?
The 7/5/3-1 rule is a guideline some investors use to evaluate fund performance over time. It looks at how a fund performs over 7-year, 5-year, and 3-year periods, and compares it to a benchmark over 1 year. While it’s one way to gauge consistency, it shouldn’t replace a broader review of fees, strategy, and risk.
Is the S&P 500 an ETF or a mutual fund?
The S&P 500 is an index, not a fund itself. You can invest in it through both ETFs (like SPY, VOO) and mutual funds (like VFIAX). Both aim to match the performance of the S&P 500, but ETFs trade like stocks during the day, while mutual funds are priced at the end of the trading day.
