ETFs vs. Mutual Funds: Which To Choose | Vanguard (2024)

FAQs

Why choose an ETF over a mutual fund? ›

ETFs usually have to disclose their holdings, so investors are rarely left in the dark about what they hold. This transparency can help you react to changes in holdings. Mutual funds typically disclose their holdings less frequently, making it more difficult for investors to gauge precisely what is in their portfolios.

If you're paying fees for a fund with a high expense ratio or paying too much in taxes each year because of undesired capital gains distributions, switching to ETFs is likely the right choice. If your current investment is in an indexed mutual fund, you can usually find an ETF that accomplishes the same thing.

The administrative costs of managing ETFs are commonly lower than those for mutual funds. ETFs keep their administrative and operational expenses down through market-based trading. Because ETFs are bought and sold on the open market, the sale of shares from one investor to another does not affect the fund.

The risks associated with owning ETFs are usually lower than those of individual stocks. But if an investor can take on the risk, then owning individual stocks can mean much higher dividend yields.

ETFs are generally considered more tax-efficient than mutual funds, owing to the fact that they typically have fewer capital gains distributions. However, they still have tax implications you must consider, both when creating your portfolio as well as when timing the sale of an ETF you hold. Internal Revenue Service.

Because the ETF is a separate legal entity from the issuer that manages it, the ETF will control all the assets in its portfolio up until the date set for its liquidation, at which point the manager will sell the assets and distribute the proceeds to investors.

An index fund is a type of mutual fund that tracks a particular market index: the S&P 500, Russell 2000, or MSCI EAFE (hence the name). Because there's no original strategy, not much active management is required and so index funds have a lower cost structure than typical mutual funds.

Holding an ETF for longer than a year may get you a more favorable capital gains tax rate when you sell your investment.

If a fund consistently underperforms over multiple periods and fails to deliver satisfactory returns, consider exiting the investment. Research and select funds with a similar investment objective but better track records and performance history to redirect your investments.

Do you pay taxes on ETFs every year? ›

For most ETFs, selling after less than a year is taxed as a short-term capital gain. ETFs held for longer than a year are taxed as long-term gains. If you sell an ETF, and buy the same (or a substantially similar) ETF after less than 30 days, you may be subject to the wash sale rule.

As we covered earlier, infrequently traded ETFs could have wide bid/ask spreads, meaning the cost of trading shares of the ETF could be high. Mutual funds, by contrast, always trade without any bid-ask spreads.

ETFs are generally lower than those that are charged by actively managed mutual funds because their managers are merely mimicking the contents of an index rather than making regular buy and sell decisions, For some investors, the design of a passive ETF is a negative.

Money managers who have spent generations building businesses based on mutual funds contend they will survive and even thrive because investors like and understand the product. It also continues to have advantages in specific areas such as small company stocks and retirement savings.

ETFs have several advantages for investors considering this vehicle. The 4 most prominent advantages are trading flexibility, portfolio diversification and risk management, lower costs versus like mutual funds, and potential tax benefits.

Why are ETFs popular? ETFs offer investors access to a wide range of markets around the world usually at low cost. Most ETFs are passive investments, meaning they simply aim to track the performance of an underlying group of investments.

Mutual funds are usually actively managed, although passively-managed index funds have become more popular. ETFs are usually passively managed and track a market index or sector sub-index. ETFs can be bought and sold just like stocks, while mutual funds can only be purchased at the end of each trading day.

At least once a year, funds must pass on any net gains they've realized. As a fund shareholder, you could be on the hook for taxes on gains even if you haven't sold any of your shares.