Exchange-Traded Funds (ETFs) vs Mutual Funds — which one is right for you?

If you have a 401(k), an employer-sponsored retirement plan, or an Individual Retirement Account (IRA), chances are you’ve heard of mutual funds. But do you know how they differ from ETFs — and which might be better suited for your investment strategy in 2025?

For decades, mutual funds have helped investors build diversified portfolios through “open-end” investment companies. These funds create a basket of investments that you can purchase as shares, giving you broad market exposure with professional management.

But what about the increasingly popular Exchange-Traded Funds (ETFs)? How do they compare? What are the pros and cons of each? Let’s break it down.

The ETF: Newer and Leaner!

While U.S. mutual funds have been around since 1924, ETFs are a newer innovation — the first one was introduced in 1993. ETFs also hold a basket of investments, often tracking a specific index like the S&P 500. They typically follow a passive investing strategy, where the goal is to mirror the performance of a market index rather than trying to beat it.

Unlike mutual funds, which are only priced once at the end of each trading day, ETFs trade on the open market throughout the day, just like individual stocks. This means prices fluctuate in real-time based on supply and demand.

ETFs are also known for lower management fees and often avoid the sales loads that some mutual funds still carry. One important distinction is how they're bought and sold. While mutual funds are redeemed by the fund company at their Net Asset Value (NAV) at the end of the day, ETFs are bought and sold between investors at market prices — which can be slightly above or below their NAV depending on market conditions.

Advantages of an ETF—Usually Better for Taxes!

One of the most appealing features of ETFs is their tax efficiency.

Mutual funds can distribute capital gains and dividends to shareholders throughout the year. This happens when companies in the fund pay dividends or when the fund manager sells holdings to rebalance the fund. Even if you reinvest those distributions, you may still owe taxes if the fund is held outside a tax-advantaged account like a 401(k) or IRA.

In contrast, ETFs use a unique creation/redemption process that helps minimize capital gains distributions. Their typically lower trading frequency, especially in passively managed ETFs, results in fewer taxable events — which can be a major plus for taxable brokerage accounts.

Some Drawbacks for ETFs, and food for thought . . .

Of course, ETFs aren’t perfect.

Because they trade on the open market, ETF investors are subject to bid-ask spreads — the difference between the highest price a buyer is willing to pay and the lowest price a seller will accept. In volatile markets, this can mean paying a premium when buying or accepting a discount when selling.

If you're investing in a down market and need to sell, you may get slightly less than the NAV of the ETF. These pricing differences can become more pronounced during periods of market stress.

Mutual funds, on the other hand, are always bought or sold at the NAV at the end of the trading day — offering a layer of price stability that some investors prefer.

Additionally, some mutual funds may be better suited for active-trading strategies or niche investment themes that require a hands-on approach. While ETFs are catching up in this space — with a growing number of sector-specific and thematic ETFs — mutual funds still offer a wide range of actively managed options.

Also, depending on your brokerage or advisor, trading ETFs could involve commissions or fees, so it's wise to double-check before investing.

At the end of the day, both Mutual Funds and ETFs provide good options for both amateur and advanced investors!

The good news is that both types of funds continue to evolve. Many mutual funds have reduced or eliminated sales loads, and now offer low-cost passive options that compete directly with ETFs. Some mutual funds even incorporate tax-managed strategies to reduce your tax liability.

Meanwhile, ETFs are expanding into active management, thematic investing, and even socially responsible strategies — once the domain of mutual funds.

Need help navigating which mutual funds or ETFs are right for you?

To help navigate which investment vehicles are right for you, a financial advisor can help you come up with solid investment options which match your needs. For more information on how we can help you please visit us at our website, or schedule a free consultation.

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