When it comes to investing, you have a lot of options. Whether it’s individual securities like stocks or fixed income like bonds, there are a lot of vehicles out there, and knowing where to invest—and when—can be difficult.

Exchange-traded funds (ETFs) and mutual funds are both popular investment vehicles that make it a little easier on investors, as they’re both professionally managed groups of individual securities or bonds. These funds have a lot in common, but they also have some significant differences that could make one or the other better suited for your personal portfolio.

Read on to learn the similarities and differences between ETFs and mutual funds and decide which is best for you.

Understanding ETFs

An ETF pools money from multiple investors to buy groups of stocks, bonds, and other securities. You buy and sell shares of an ETF on a stock exchange, just as you would buy and sell shares of stock, which is why they’re called exchange-traded funds.

An ETF typically tracks a specific commodity or market index, which makes them easy to understand and convenient to trade. In exchange for this convenience, investors in an ETF pay the fund company a fee via an expense ratio that is charged as a percentage of the assets managed.

Like traditional stocks, you can purchase as little as one share in an ETF. This makes ETFs easier to get into than some other forms of investments. They can also be day traded, sold short, and otherwise managed just like stocks.

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Understanding Mutual Funds

A mutual fund also pools money from multiple investors to buy groups of stocks, bonds, and other securities. Unlike ETFs, however, mutual funds aren’t sold on stock exchanges. Instead, you buy shares of a mutual fund directly from the company managing the fund.

Most mutual funds are actively managed, with a fund manager making independent decisions to buy and sell securities within the fund. Depending on the skill of the fund manager, this can provide a potential upside. Other mutual funds are designed to track a market index, however, which makes them more closely track market trends.

Additionally, you can’t buy just one share of a mutual fund; you typically have to invest a set dollar amount. While some funds let you buy in for as little as a few hundred dollars, others require a minimum investment of several thousand dollars.

You also can’t trade shares in a mutual fund as you can with ETFs and traditional securities. If you want to change your position, you have to sell those assets back to the mutual fund itself.

How ETFs and Mutual Funds Are Similar

ETFs and mutual funds are similar in many ways, including:

• Structure—Both utilize pools of individual securities.
• Diversification—Both offer a more diversified investment than a single stock or bond. You can build a diversified portfolio from a single ETF or mutual fund investment.
• Risk hedging—Because of this built-in diversification, both ETFs and mutual funds carry less risk compared to handpicked stocks or bonds.
• Variety—Both ETFs and mutual funds provide access to a wide variety of securities.
• Management—Expert fund managers manage both pooled investments and select and monitor the securities included in each fund.

How ETFs and Mutual Funds Are Different

Even though ETFs and mutual funds are structured similarly, they’re different in several ways, including:

• Fund management—Perhaps the biggest difference between ETFs and mutual funds is the approach of the different fund managers. ETFs are typically passively managed funds designed to track a specific market index. Mutual funds are typically actively managed by fund managers who use their investing expertise to constantly buy and sell securities within the funds to outperform the market. Of course, this means that less-skilled fund managers can cause their funds to underperform the market, too.
• Expense ratios—Passively managed ETFs have relatively low management costs, often as low as 0.03%. Actively managed mutual funds typically have higher management costs, often as high as 0.60%. Those higher costs can often outweigh any extra gains you may make with a mutual fund over an ETF.
• Trading—ETFs are traded just like traditional stocks, one share at a time at any time, including via intraday trading. Mutual funds, on the other hand, are traded in larger blocks and priced only at the end of each trading day.
• Minimum investment—ETFs have a low cost of entry, as little as the cost of a single share. Mutual funds require a higher minimum investment, typically $1,000 or more.
• Taxes—ETFs are structured in a more tax-efficient fashion and aren’t subject to capital gains taxes unless and until shares are sold for a profit. Mutual funds, in contrast, typically incur higher capital gains taxes.

ETFs and mutual funds are both popular investment vehicles, combining to account for almost half (48.1%) of total worldwide assets.

Are ETFs or Mutual Funds Right for Me?

Which of the two is the best for your investment portfolio? It all depends on your personal investment strategy.

ETFs might be for you if:

• You’re tax sensitive—While both ETFs and mutual funds are more tax efficient than many other types of investments, ETFs are generally more tax efficient than mutual funds. Because ETFs trade on exchanges from one investor to another, they typically encounter fewer taxable events. This contrasts with mutual funds that trigger tax liability when shares are redeemed.
• You want lower investment minimums—You can buy an ETF for as little as the price of a single share. Mutual funds, in contrast, require a flat, and often large, dollar amount investment.
• You want more control over the price of your trade—ETFs are priced in real time and let you place more sophisticated types of orders that give you more control over the price you pay. Mutual funds, on the other hand, trade at the same price for all investors on a given day—and you don’t know that price until the end of the trading day. You don’t have any control over that.

Meanwhile, mutual funds might be better suited for you if:

• You make frequent investments—If you make regular deposits in your portfolio, a stable mutual fund is more cost-effective than a more volatile ETF. No-load mutual funds let you put in the same dollar amount each time you invest. With ETFs, you never know what the day’s price will be.
• You want to automatically repeat transactions—Mutual funds let you set up automatic investments and withdrawals to and from the account. ETFs don’t.
• You’re in a less efficient market—Highly efficient markets don’t provide much opportunity for portfolio managers to add much value. In less-efficient, high-yield or emerging markets, however, mutual fund managers have more opportunity to add value.

Knowing where to invest, how much, and when can sometimes be a difficult decision. With so many options out there, how do you know which one is right for you?

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