When you start investing, you are often presented with two main choices for diversified growth: Exchange-Traded Funds (ETFs) and Mutual Funds. Both hold baskets of stocks, but they work very differently.
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1. Trading Flexibility
ETFs trade like stocks. You can buy and sell them instantly throughout the day. You can see the price change second by second.
Mutual Funds only trade once a day, after the market closes (4 PM ET). No matter when you place your order, you get the closing price.
2. Fees (Expense Ratios)
Generally, ETFs are cheaper. Many passive ETFs (like VOO or SPY) have expense ratios as low as 0.03%. Mutual funds, especially actively managed ones, often charge 0.50% to 1.5%.
"A 1% fee sounds small, but over 30 years, it can eat up 25% of your total returns."
3. Tax Efficiency
ETFs are generally more tax-efficient. Due to their unique structure, they generate fewer "capital gains distributions" than mutual funds. This means you pay less tax while holding them in a taxable brokerage account.
Which One Wins?
- Choose ETFs if: You want lower fees, tax efficiency, and the ability to trade intraday.
- Choose Mutual Funds if: You are investing in a 401(k) (often your only choice) or you want to automate investing specific dollar amounts (e.g., $500/month exactly).