What Is The Difference Between an ETF and a Managed Fund?
How to understand the difference in fund structures and pick the correct fund for you.
If you’ve started investing, you’ve likely come across two of the most popular ways to grow your money: ETFs (exchange-traded funds) and managed funds (often called mutual funds). Both pool money from a series of investors to buy a diversified blend of assets, be it stocks, bonds, or alternatives, like cryptocurrency.
But they operate in distinct ways, which will impact your investing experience.
Understanding how these structures differ is crucial to building an efficient, tax-aware, and goal-oriented portfolio. Below, we’ll break down how ETFs and managed funds compare across structure, fees, taxes, and investment suitability.
Structural and Operational Differences
At their core, both ETFs and managed funds aim to make diversified investing simple. The key difference lies in how they’re built and traded.
ETFs trade on stock exchanges, just like individual stocks. Their prices fluctuate throughout the day based on supply and demand. Investors can buy or sell ETF shares at any time during market hours.
Most ETFs are passively managed, meaning they track a specific index (such as the S&P 500) rather than relying on fund managers to manually select securities. However, actively managed ETFs have become more popular, allowing professional managers to adjust holdings within the ETF structure based on their clients specific investment needs, such as a tax-efficient portfolio. Twin Oak’s actively managed ETFs, for example, fall into this category.
Mutual funds, on the other hand, are bought directly from the fund company at the end of each trading day. They are priced once daily, based on the fund’s net asset value (NAV).Managed funds are almost always actively managed, with professional portfolio managers choosing securities in an attempt to outperform the market. Because of this hands-on approach, their operational costs and investor fees tend to be higher.
Pros and Cons: Fees, Expense Ratios, and Cost Transparency
Fees are one of the biggest differentiators between ETFs and managed funds, and one of the most crucial to understand when evaluating your long-term returns.
ETFs are known for low expense ratios. Because most are passively managed, they don’t require expensive research teams or constant trading. Many ETFs that track an index charge less than 0.10% per year in management fees. ETFs also tend to be more transparent. They publish their holdings daily, and trading costs are visible in the market.
Mutual funds often charge higher expense ratios, typically ranging from 0.50% to 1.5% annually. These fees compensate portfolio managers and analysts who actively pick investments.Some managed funds also impose commissions, which can further reduce returns.
ETFs offer real-time visibility into trading costs and holdings, while mutual funds provide disclosures quarterly or semi-annually. For investors who value cost clarity and control, ETFs often have the edge.
Tax Implications
Tax efficiency is another major area where ETFs and managed funds diverge, especially for investors holding assets in taxable accounts.
ETFs are generally more tax-efficient thanks to their “in-kind” creation and redemption process. When investors buy or sell ETF shares, the transactions occur between investors on an exchange, and when institutional investors redeem shares, ETFs can deliver underlying securities “in kind” rather than selling them. This structure allows ETFs to avoid triggering capital gains taxes for remaining shareholders. Investors typically owe taxes only when they sell their own ETF shares.
Mutual funds, by contrast, must sell securities when rebalancing, or to meet redemptions when investors cash out. These sales often generate capital gains distributions, or taxable events passed on to all fund shareholders, even those who didn’t sell their shares.
When Does One Make More Sense Than the Other?
Choosing an ETF or a mutual fund often depends on your investment goals and account type.
- Long-Term Passive Investors: ETFs typically make more sense for buy-and-hold investors seeking low-cost, diversified exposure. A simple portfolio of index ETFs can form the foundation of a retirement or taxable investment strategy.
- Active Investors or Retirement Plans: Managed funds can be suitable for investors who prefer professional oversight or want to access strategies unavailable in ETF form. They’re also common in employer-sponsored plans, where fund access and fees are often negotiated. But active management in ETFs is also becoming more common.
- High-Net-Worth Investors and Family Offices: ETFs tend to outperform mutual funds on an after-tax, after-fee basis, which is crucial for investors with a large amount of capital invested in a taxable brokerage account.
Which One Is Right For You?
Both ETFs and managed funds can play valuable roles in a diversified investment strategy. ETFs offer low-cost, tax-efficient, and transparent access to the markets, which is ideal for hands-off, long-term investors. Managed funds, meanwhile, provide active management and structure suited to automated or institutional settings.
The key is to understand how each works, what you’re paying for, and how it fits within your broader financial goals. Whether you prefer the simplicity of index ETFs or the hands-on approach of an actively managed fund, the best choice is the one that aligns with your investment plans and long-term outlook.
