Differences Between ETFs vs. Index Funds vs. Mutual Funds

ETFs, index funds and mutual funds are common types of investment vehicles that pool investor money to buy diversified portfolios of assets. However, each differs in structure, management and trading methods. When determining the asset allocation for your portfolio, it helps to understand key differences between an ETF vs. index fund vs. mutual fund to ensure you make the right investment decisions for your future.

A financial advisor can help you determine the best investment opportunities based on your long-term goals.

What Are ETFs?

Exchange-traded funds (ETFs) are investment funds traded on stock exchanges, much like individual stocks. The concept of ETFs was introduced in the early 1990s as a blend of mutual funds and individual stocks.

ETFs are traded like stocks, providing high liquidity to investors. With lower expense ratios and high tax efficiency, they are an attractive choice when building a portfolio.

Prominent ETFs today include SPDR S&P 500 ETF (SPY), Invesco QQQ Trust (QQQ) and Vanguard Total Stock Market ETF (VTI).

What Are Index Funds?

Index funds are types of mutual funds or ETFs that aim to replicate the performance of a specific index. They track specific indexes with passive management, resulting in lower costs while investors benefit from diversified portfolios.

The first index fund was created in the 1970s by John Bogle, the founder of the Vanguard Group. Today, popular index funds include the Vanguard 500 Index Fund (VFIAX) and Fidelity ZERO Total Market Index Fund (FZROX).

What Are Mutual Funds?

Mutual funds are perhaps the most well-known type of investment fund.

Established in 1924, the first modern mutual fund, the Massachusetts Investors Trust from MFS Investment Management, offered investors the opportunity to pool their money for diversification and professional management. Notable mutual funds today include T. Rowe Price Equity Income Fund (PRFDX) and Vanguard Total Bond Market Index Fund (VBTLX).

Mutual funds offer the benefit of professional management, as they tend to be actively managed. In addition to this convenience, investors are better able to diversify their portfolios.

Differences Between ETFs, Index Funds and Mutual Funds

When comparing an ETF vs. index fund vs. mutual fund, there are both similarities and differences. For example, all three pool investor money to buy a diversified portfolio of assets. However, each differs significantly in structure, management style and trading characteristics.

One key distinction is how they are traded. ETFs can be traded like stocks, picked up or dropped at any time during trading hours. Mutual funds, however, can only be purchased at the end of the market day.

Index funds, on the other hand, are a type of mutual fund or ETF. As such, they get traded and settled according to their structure, whether that is a mutual fund or ETF. Therefore, an index ETF purchase order would not execute end-of-day net asset value (NAV) like an index mutual fund.

Another consideration is the total cost of investing. ETFs and index funds tend to have lower expense ratios, which lowers the total cost when compared with actively managed professional mutual funds. This is something that should be factored into the total return, as you will be paying less of that return to a firm.

When to Choose Each Type

A man calculating the differences between ETFs, mutual funds and index funds.

With three popular investment fund options available — an ETF vs. index fund vs. mutual fund — it is important to choose the one that best aligns with your long-term financial goals, time horizon and investment style.

These considerations can help you decide which option might be right for you.

ETFs (exchange-traded funds): Best for investors who want flexibility, low costs and tax efficiency. ETFs are ideal if you prefer to trade throughout the day, take advantage of market fluctuations or minimize taxable distributions. They work well for hands-on investors and those looking for cost-effective exposure to specific sectors or strategies.
Index funds: Well-suited to long-term, hands-off investors who want to match the market’s performance at low cost. Since index funds track an entire index, they are a useful tool when building a diversified portfolio and allowing it to grow over time without frequent monitoring.
Mutual funds: A good fit for those who value professional management and are comfortable paying slightly higher fees for that guidance. Mutual funds are also convenient for investors who want an automatic investment plan, easy reinvestment of dividends and do not need to trade during market hours.

How to Buy and Sell Each Type of Fund

Once you have decided which type of fund works for you, the next step is to understand how to buy and sell it.

ETFs: ETFs are purchased and sold just like stocks on a stock exchange. You can buy them through a brokerage account, and the price fluctuates throughout the trading day. This intraday trading allows for more flexibility in timing your purchase or sale. ETFs also often have no minimum investment, making them accessible to most investors.
Index funds: Index funds can be structured as either mutual funds or ETFs, so how you buy them depends on which format you choose. If you opt for an index mutual fund, you can buy directly from the fund company or through a brokerage account, but purchases execute at the end-of-day net asset value (NAV). If you choose an index ETF, you will buy it just like any other ETF on an exchange.
Mutual funds: Mutual funds are typically bought directly through the fund company, through your financial advisor or via a brokerage platform. Unlike ETFs, mutual fund transactions happen once per day after the markets close, and they are priced at the day’s closing NAV. Some funds may have minimum investment requirements, so it is worth doing your research before you invest.

Bottom Line

A financial advisor comparing ETFs, index funds and mutual funds for a couple.

ETFs, index funds and mutual funds each offer unique advantages, as well as potential drawbacks. The best choice will depend on your financial goals, risk tolerance and investment strategy. For this reason, a financial advisor can be of immense help, providing guidance when deciding which investment option is best for you. By understanding the differences between these types of funds and taking professional advice before investing, you are more likely to make more successful investment outcomes.

Work with a financial advisor to develop the right investment strategy for your portfolio to build long-term wealth.

Tips for Investing

Choosing the right type of investment for your situation can be difficult, especially if you’re not experienced in the market. A financial advisor can offer expertise to help you match the right investment choices to your long-term financial goals. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
You can use an investment calculator to help you estimate potential returns, based on the assets you choose in your portfolio, over a specific period of time.