Is an ETF safer than a mutual fund?

Neither is safer by structure. Risk comes from what the fund holds. An S&P 500 ETF and an S&P 500 mutual fund carry the same market risk.

Can I buy an ETF with a small amount of money?

Yes. ETFs are bought by the share, and most brokers offer fractional shares, so you can invest $25 in a fund whose share price is $500.

What is an index fund?

A fund, either mutual fund or ETF, that copies an index such as the S&P 500 instead of picking stocks. Index funds have lower costs and, over long periods, have beaten most actively managed funds.

Mutual Funds vs. ETFs: Differences, Costs and Which to Pick

A mutual fund collects money from many investors and uses it to buy a portfolio of stocks, bonds or both. You own units of the fund rather than the individual holdings. An ETF does the same thing, but trades on an exchange like a stock.

For decades mutual funds were the default way to invest for retirement. ETFs have taken over new money because they are usually cheaper and more flexible. Here is how they differ.

How each one trades

A mutual fund is priced once a day. Orders placed during the day execute at that evening’s net asset value, the total value of holdings divided by units. You never know the exact price when you place the order.

An ETF trades continuously during market hours at a price set by buyers and sellers, usually within a whisker of its net asset value. You can use limit orders, see the price instantly and even trade it in the last minute of the session.

Costs

Both charge an expense ratio, an annual percentage deducted from the fund’s assets. Index ETFs from the largest providers charge as little as 0.03%. Actively managed mutual funds commonly charge 0.5% to 1% or more.

Some mutual funds also carry sales loads, a commission on the way in or out, and minimum investments of $1,000 or more. Most ETFs have no load and can be bought one share, or one fraction of a share, at a time.

Taxes

When a mutual fund sells holdings at a gain, it must distribute those gains to all unit holders, who owe tax even if they never sold. ETFs use an in-kind creation and redemption process that lets them avoid most of those distributions.

In a taxable account this makes ETFs materially more efficient. Inside a tax-sheltered retirement account the difference disappears.

When a mutual fund still makes sense

Employer retirement plans often offer only mutual funds. Automatic investing of a fixed dollar amount each month is simpler with a fund, though most brokers now support it for ETFs too. Some strategies, such as certain bond and money-market funds, exist only in mutual-fund form.

For most self-directed investors building a portfolio from scratch, a low-cost index ETF does the same job for less.

Mutual Funds vs. ETFs: What Is the Difference?