Two ways to own a basket

An exchange-traded fund (ETF) and a mutual fund do the same basic job: they pool money from many investors and buy a basket of assets, such as the 500 companies in the S&P 500. One purchase gives you a slice of all of them, which is how ordinary investors get diversification without buying hundreds of holdings. The difference is the wrapper, how you buy and hold the basket, not usually what is inside it.

How they trade

This is the clearest difference.

• An ETF trades on a stock exchange throughout the day, like a share. You see a live price and can buy or sell whenever the market is open.
• A mutual fund is priced once a day, after the market closes, at its net asset value. Your order fills at that single daily price whatever time you placed it.

For a long-term investor this rarely matters. For anyone who wants to trade during the day, the ETF is the only one of the two that allows it.

Fees: the part that actually compounds

Over decades, fees matter more than almost anything else you can control, because every dollar paid in charges is one that stops compounding. On average, ETFs are cheaper. One widely cited comparison puts the average ETF expense ratio near 0.14 percent against about 0.40 percent for mutual funds.

But the average hides the real story. The large gap is between active funds, which pay a manager to try to beat the market, and passive index funds, which simply track it. For two index funds tracking the same benchmark, the cost is almost identical: Vanguard's S&P 500 ETF charges 0.03 percent a year, and its S&P 500 mutual fund charges 0.04 percent. That difference is noise.

Two other fee points favour ETFs. Some mutual funds charge a sales load, a commission of 3 percent to 5.75 percent to buy or sell, where most ETFs have none. And most brokers now charge no commission to trade ETFs, as with shares.

Taxes

In a taxable account, ETFs are usually more tax-efficient. Their structure lets them avoid passing on many of the capital-gains distributions that mutual funds hand to holders each year. Inside a tax-sheltered retirement account, this advantage mostly disappears.

Minimums and access

Many mutual funds ask for a minimum first investment, often 1,000 to 3,000 dollars. An ETF can be bought as a single share, and with fractional investing now common, often for a few dollars. For someone starting small, that lowers the barrier.

So which should you choose?

For most long-term, low-cost index investing, an ETF has a slight edge on fees and taxes and a lower entry point. But a low-cost index mutual fund can be just as cheap and is often easier to buy in regular automatic amounts. The honest answer is to compare the specific funds, not the labels. Before buying, check the expense ratio, any sales load or transaction fee, whether your broker charges commission, and whether the account is taxable. Our fees tracker keeps a sourced list of what common products cost, and for the bigger picture of what goes inside these funds, see stocks vs bonds.

The bottom line

ETFs and mutual funds are two containers for the same idea: cheap, diversified exposure to a market. The ETF wins on intraday trading, tax efficiency and entry price; a good index mutual fund matches it on cost and suits automatic investing. Pick the fund by its fee and what it holds, and the wrapper becomes a detail. The glossary defines the terms along the way.