With ETFs Skyrocketing, Should You Give Up on Mutual Funds?

It’s important to understand both ETFs and mutual funds before deciding which one is right for you. metamorworks/Shutterstock

Exchange-traded funds (ETFs) are piercing through 2025 following a stellar year. In fact, ETFs hit a record net inflow of $1.3 trillion in November 2024, bringing total assets to a total of more than $10 trillion. ETFs have long been recognized by investors for their low fees and professional management, which makes these vital options for novice investors looking to build a diversified portfolio.

However, their longer-established cousins, mutual funds, still reign supreme when it comes to assets under management (AUM). Mutual funds have more than $25 trillion in AUM. And they have been around since the 1920s. ETFs can trace their history back only to the 1990s.

But both ETFs and mutual funds stand out to investors. Both are baskets of different stocks, bonds, and other securities that offer instant diversification and are professionally managed. Both can offer advantages for all kinds of investors from beginners to institutional. But they are structured differently and have different tax implications, as well as cost considerations.

So it’s important to understand both ETFs and mutual funds before deciding which one is right for you.

What Are ETFs, and How Do They Work?

You can think of ETFs as packages that contain different stocks, bonds, and other securities. You can buy shares of ETFs on a stock exchange through your brokerage account in the same way you can buy shares of an individual stock. And as with a stock, the price of an ETF share changes throughout the trading day.

Most ETFs are index ETFs, which are passively managed. This means they’re designed to reflect the return of a broad index such as the S&P 500 or the Nasdaq Composite.

There are other types of passively managed ETFs. Some track bond indexes, for example. And instead of investing in a broad index of various stocks from different industries, some ETFs invest only in stocks from a particular sector, such as tech, financials, and energy.

You can also find actively managed ETFs. These ETFs aim to outperform a particular index. Their management teams use research and other sources to actively buy and sell different securities within the fund to support this goal.

What Are Mutual Funds, and How Do They Work?

Like ETFs, mutual funds invest in a variety of securities such as stocks and bonds. But mutual funds are priced differently. Mutual fund share prices don’t change throughout the trading day as ETF shares do. The price of a mutual fund share is based on the fund’s net asset value (NAV), which is calculated at the end of each trading day. This means investors buying a share of a mutual fund on the same day pay the same price.

But what exactly is NAV? The NAV is the total value of all the assets in the fund’s portfolio minus any liabilities, divided by the number of outstanding shares.

Most mutual funds are actively managed, but you can also find passively managed options. And as with ETFs, there are also mutual funds that invest in stocks from particular industries and sectors. Some mutual funds also invest in bonds.

ETFs Versus Mutual Funds: The Costs

When it comes to investing in either ETFs or mutual funds, fees of any kind can eat away at your returns. So it’s important to pay attention to exactly what it costs you to own a share of either an ETF or mutual fund.

To understand this concept, it could help to begin with understanding how the fund you want to invest in is managed. Passively managed funds generally have lower management fees or expense ratios. This is because the fund managers merely try to mimic the return of a target index. For example, the management team of a mutual fund or ETF tracking the S&P 500 may choose to invest in all stocks within the index in order to reflect its return. If the index goes up, you can expect the fund to go up as well.

There’s also not much in the way of trading, as the managers may choose to only change their holdings when the S&P 500 removes or adds a stock. This “passive” approach generally keeps fees low.

On the other hand, the management team actively managing an ETF or mutual fund can choose to buy and sell stocks within the index using research and analysis in order to come up with a strategy that would help it beat the return of that index. But with this higher level of engagement comes higher management fees. Active trading within the fund could also trigger capital gains taxes for investors.

The average expense ratio for active funds is 0.6 percent, according to research by Morningstar. The average expense ratio for passive funds is about 0.4 percent.

It’s important to highlight that most mutual funds are actively managed and most ETFs are passively managed. But this doesn’t mean you won’t find mutual funds with lower expense ratios than ETFs with similar holdings and investment goals. So it’s important to do your research. Some brokerages offer proprietary ETFs and mutual funds that charge zero percent expense ratios.

Other Costs

There’s more to the cost of ETFs and mutual funds than expense ratios. Although rare these days, you may be charged a commission for trading ETF shares. Moreover, some mutual funds have investment minimums. These minimums generally range from $500 to $3,000. But you can find limits that are much lower and much higher. Still, some mutual funds allow you to buy fractional shares based on a dollar amount of your choosing.

In addition, some mutual funds may charge sales loads or commissions. A front-end load is a one-time fee charged when purchasing mutual fund shares. Back-end loads are one-time fees charged when selling shares of a mutual fund. These may be waived if you hold the shares for a certain amount of time. Nonetheless, you can find no-load mutual funds.

Who Should Invest in ETFs?

If you’re an active trader, you may find ETFs appealing. ETF share prices change throughout the day like stocks, so they may offer some opportunity for those who speculate and are prone to technical analysis. You can also engage in ETF options trading, short selling, stop orders, and limit orders with ETFs. This isn’t the case with mutual funds.

Further, you may find that ETFs generally are more tax-efficient than mutual funds. Because most ETFs are passively managed, their fund managers don’t engage in much trading within the fund. Therefore, they could minimize capital gains taxes.

Who Should Invest in Mutual Funds?

If you’re a “set it and forget it” investor, you may be interested in mutual funds. Because mutual funds allow you to purchase fractional shares, you can set aside a certain amount each month to contribute toward a mutual fund. This practice lets you take advantage of dollar-cost averaging, which allows you to essentially pay less per share over time by purchasing more shares with the same amount of money when share prices are low.

Mutual funds may also appeal to those who seek actively managed funds that could beat the market. There are a variety of actively managed mutual funds out there that engage in different strategies, and this could give you a high level of customization.

But no rule states you can’t have both mutual funds and ETFs.

Investing in Mutual Funds and ETFs

You could benefit from a diversified portfolio containing both ETFs and mutual funds. Before you take this approach, however, it’s important to understand your investment goals. Use this to help you decide on a strategy: passive, active, or a mix of both. Then, do your research. Carefully examine the funds at your disposal as well as their fees and expense ratios, holdings, management team, performance, and more. Finally, decide which ones may complement your overall investment strategy.

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