An investor holds an actively managed stock mutual fund in a taxable brokerage account. The fund ends the year down 4%. In December it pays a capital gains distribution anyway, because the manager sold shares that had risen in earlier years to meet redemptions from other investors. The investor owes tax on a gain in a year the investment lost money. A neighbor who owns an ETF on the same kind of stocks gets no such bill, and the reason has nothing to do with the stocks inside.
In 2025, 57% of equity mutual funds paid a capital gains distribution against 6% of equity ETFs. The other differences are in how each is traded and what each costs. What the fund can hold is set by the same law for both.
Two wrappers for the same portfolio
- Mutual fund
- A fund that issues and redeems its own shares once a day at net asset value, the value of its holdings divided by its shares, calculated after the market closes.
- Exchange-traded fund (ETF)
- A fund whose shares trade on a stock exchange all day at market prices. Large dealers called authorized participants create and redeem shares with the fund in big blocks, usually by delivering or receiving the underlying securities instead of cash.
- Index fund
- A strategy: a fund that tracks an index. It can be packaged as a mutual fund or as an ETF, and many index funds exist in both forms.
Both are registered investment companies under the Investment Company Act of 1940, with the same limits on leverage and illiquid holdings, the same custody rules and the same board oversight, rules our comparison of hedge funds and mutual funds sets out. At the end of 2025, US mutual funds held 31.4 trillion dollars in 8,030 funds, and US ETFs held 13.4 trillion dollars in 4,495 funds.
Money is moving from one to the other. In 2025 long-term mutual funds had 1.2 trillion dollars of net outflows, while ETFs had a record 1.5 trillion dollars of net share issuance.
ETFs and mutual funds compared
| ETF | Mutual fund | |
|---|---|---|
| How you buy and sell | On an exchange through a broker, any time the market is open | From the fund or a broker, once a day |
| Price you get | Market price, which can differ from NAV | That day's NAV, for every investor |
| Trading cost | Bid-ask spread, sometimes a commission | None for no-load funds, sales loads on some share classes |
| Average expense ratio, index equity, 2025 | 0.14% | 0.05% |
| Average expense ratio, active equity, 2025 | 0.44% | 0.64% |
| Equity funds paying capital gains in 2025 | 6% | 57% |
| Holdings disclosure | Daily | Quarterly |
| Minimum investment | One share, or less with fractional shares | Set by the fund, often 0 to 3,000 dollars |
| Short selling, margin, limit orders | Yes | No |
Expense ratios are asset-weighted averages from the ICI 2026 Fact Book.
Why ETFs pay fewer capital gains distributions
A mutual fund that faces redemptions usually sells securities for cash to pay the departing investor. If those securities have risen since the fund bought them, the fund realizes a gain, and funds distribute almost all realized gains to shareholders to avoid paying tax at the fund level. The remaining shareholders receive a taxable distribution for a sale they did not ask for.
An ETF handles most redemptions differently:
- An authorized participant hands the fund a large block of ETF shares.
- The fund pays the dealer with a basket of the securities it holds, and can pick the tax lots to manage its cost basis, typically handing over the lowest-basis shares.
- Under section 852(b)(6) of the tax code, a regulated investment company does not recognize a gain when it distributes property to redeem its shares on demand.
The low-basis shares leave the fund without a taxable sale, and the embedded gains leave with them. When ETF investors trade with each other on the exchange, the fund is not involved at all. Across all funds, 7% of ETFs and 52% of mutual funds paid a capital gain in 2025, and the averages since 2016 are 9% and 53%.
Three limits apply. Index mutual funds with low turnover also distribute little, so the gap is widest against active mutual funds. Bond ETFs deliver most of their return as taxable interest, which the in-kind process does not touch. And inside an IRA or 401(k), capital gains distributions are not taxed when paid, so the advantage disappears.
Expense ratios in 2025
Across all equity mutual funds, the asset-weighted expense ratio fell from 0.99% in 2000 to 0.40% in 2025. The 2025 averages by type:
- Index equity mutual funds charged 0.05%, index equity ETFs 0.14%.
- Active equity mutual funds charged 0.64%, active equity ETFs 0.44%.
- Index bond mutual funds charged 0.05%, index bond ETFs 0.09%.
- Active bond mutual funds charged 0.44%, active bond ETFs 0.33%.
Asset-weighted averages are pulled toward the largest funds. The simple average for index equity ETFs is 0.45%, so cost comparisons have to be made fund by fund. Vanguard's 500 Index Fund Admiral shares charge 0.04% with a 3,000 dollar minimum, and Fidelity's ZERO Total Market Index Fund charges 0.00% with no minimum.
Over long periods the fee gap compounds. Assume, purely for illustration, 100,000 dollars and a 6% gross annual return for 20 years:
| Expense ratio | Ending value | Lost to fees |
|---|---|---|
| 0.05%, index mutual fund average | 317,701 | 3,012 |
| 0.14%, index equity ETF average | 312,347 | 8,366 |
| 0.64%, active equity mutual fund average | 284,129 | 36,585 |
Mutual funds sold through brokers can also carry sales loads. FINRA Rule 2341 caps front-end and deferred sales charges combined at 8.5% of the offering price for funds without an ongoing asset-based sales charge. No-load funds bought directly from the fund company carry none. Our article on active and passive investing covers what the fee gap does to returns across whole categories.
Trading costs: spreads, premiums and discounts
A mutual fund order placed at 10 a.m. is filled at the net asset value calculated after 4 p.m., the same price for everyone that day, as Rule 22c-1 requires. You do not know the price when you place the order, and you pay no spread.
An ETF order is filled at whatever the market offers. For the largest funds the cost is tiny: the iShares Core S&P 500 ETF had a 30-day median bid-ask spread of 0.01% in September 2026. For thinly traded ETFs the spread can be much wider, and it is paid on every purchase and every sale.
Market prices can also drift away from the value of the holdings. On March 12, 2020, the iShares iBoxx Investment Grade Corporate Bond ETF closed 4.5% below the fair value of its bonds, against a usual gap of about 0.06%. Its average absolute premium or discount went from 0.13% in January and February 2020 to 1.39% in March and April. An investor forced to sell that week took the discount, and a mutual fund holder redeeming the same day received the fund's own valuation of the bonds.
Since the SEC's 2019 ETF rule, every ETF must publish on its website each day its holdings, the previous day's premium or discount, its median bid-ask spread, and a warning if the premium or discount has exceeded 2% for more than seven trading days in a row. Checking those numbers and using limit orders keeps the trading cost visible.
Holdings disclosure
ETFs publish their full portfolio every business day, before the market opens, under Rule 6c-11. Mutual funds report holdings to the SEC monthly on Form N-PORT, but only the report for the third month of each quarter becomes public, and funds have up to 60 days after the quarter to file it. A 2024 rule that would publish every month has been pushed to November 2027, and in February 2026 the SEC proposed keeping public reports quarterly.
For an index fund the difference hardly matters, since the index is public. For an active fund, daily disclosure shows other traders the manager's positions while they are still being built.
Minimums, automatic investing and 401(k) plans
An ETF costs one share, or less where the broker sells fractional shares. A mutual fund sets its own minimum, commonly between zero and a few thousand dollars, and then accepts any dollar amount, including fractions of a share. That makes mutual funds the simpler vehicle for fixed monthly contributions.
Workplace plans run on that model. At the end of 2025, 57% of the 10.1 trillion dollars in 401(k) plans sat in mutual funds. Most of the rest is in collective investment trusts, bank-maintained pools that are not registered funds and cost less to run, whose share of 401(k) assets rose from 6% in 2000 to 38% in 2023.
Mutual funds turning into ETFs
A mutual fund can reorganize into an ETF. In 2025 a record 60 funds from 31 firms converted, and over five years 203 conversions moved more than 260 billion dollars into the ETF structure.
A fund can also add an ETF share class: one fund, one portfolio, with a mutual fund class and an ETF class side by side. Vanguard used this structure for two decades under a patent that expired in 2023. Other managers needed SEC exemptive relief, and Dimensional received the first approval on November 17, 2025. Its first active ETF share class, on a US micro cap fund, launched in March 2026. Dozens of other managers have applied for the same relief.
When both classes hold the same portfolio, redemptions in the ETF class can be met in kind, which can reduce the gains the whole fund realizes, including for mutual fund shareholders.
Switching between the two
In an IRA or 401(k), moving from a mutual fund to an ETF has no tax effect. In a taxable account, selling the mutual fund realizes any gain or loss. A loss can be disallowed under the wash-sale rule if you buy a substantially identical security within 30 days before or after the sale, and IRS Publication 550 tells taxpayers to consider all the facts and circumstances without saying whether two funds tracking the same index count. For an investor sitting on a large unrealized gain in an old mutual fund, the tax on selling can exceed years of the fee and distribution savings.
This article is general information, not investment advice.
Frequently asked questions
What are the disadvantages of ETFs compared with mutual funds?
You buy and sell at a market price, so you pay a bid-ask spread and can pay a premium or receive a discount to the fund's net asset value, which widened to about 4.5% on a large corporate bond ETF in March 2020. ETFs are harder to use for automatic fixed-dollar contributions unless the broker offers fractional shares, they are rare in 401(k) plans, and the ease of intraday trading makes frequent trading easier.
What did Warren Buffett say about index funds and ETFs?
In his 2013 letter to Berkshire Hathaway shareholders, Buffett described the instructions he left for his wife's inheritance: 10% in short-term government bonds and 90% in a very low-cost S&P 500 index fund, adding that he suggested Vanguard's. He was describing an index fund, and the same index is available as both a mutual fund and an ETF.
Are ETFs safer than mutual funds?
No, the wrapper does not change the risk of what the fund holds. Both are registered under the Investment Company Act of 1940, and an S&P 500 ETF and an S&P 500 mutual fund hold the same stocks. The differences are in cost, taxes and how you trade, plus the market-price risk that an ETF can trade away from its net asset value in stressed markets.
Can I switch from a mutual fund to an ETF on the same index without paying tax?
In a taxable account, selling the mutual fund is a taxable sale. If you sell at a loss and buy an ETF on the same index within 30 days, the wash-sale rule may disallow the loss, because the IRS gives no definition of substantially identical that settles whether two funds on the same index qualify. In an IRA or 401(k), switching has no immediate tax effect.