ETF vs mutual fund: key differences explained

When considering the difference between ETF and mutual fund, it’s easy to get confused. They have many similarities as they both work with a mixture of various kinds of assets givinginvestors a chance to diversify their choices of assets, thus lowering the element of risk.

In this Moneyfarm guide we’ll explain how ETFs differ from mutual funds and what those differences may mean for you as a UK investor.

At a glance

• ETFs and mutual funds both offer diversification across multiple assets
• ETFs are typically traded on an exchange throughout the day, mutual funds are usually priced once daily
• Many ETFs are passively managed and tend to have lower ongoing costs
• Mutual funds are often actively managed, though low-cost index mutual funds also exist
• UK taxation depends heavily on whether investments are held inside an ISA or pension wrapper

What is an ETF?

An ETF is a kind of investment that is based on stocks being traded via an exchange market. It can hold a variety of assets, including stocks and bonds, commodities, and also currencies. An ETF allows trading to take place throughout the day. Many ETFs now work through Robo advisers.

What is a mutual fund?

A mutual fund consists of a number or pool of investments or money that is collected from numerous investors. The money is then used for lump investments in stocks and bonds, and other assets that have the potential for high returns. They are usually managed in an active way by professional fund managers.

ETF vs mutual fund in investing: key differences

The key differences between ETFs and mutual funds lie in how they are managed and how investors can buy or sell them. While both vehicles offer diversification, their structure can influence costs, flexibility and overall investment experience.

In the sections that follow, we look at how ETFs differ from mutual funds and what those differences may mean for you as an individual investor, starting with how each type of fund is managed.

Management style and costs

One of the most commonly cited differences between ETFs and mutual funds is how they are managed.

• ETFs are most often passively managed, tracking a benchmark index like the FTSE 100, the Nasdaq, or the S&P 500. This generally results in lower ongoing charges, although actively managed ETFs do exist and tend to be more expensive.
• Mutual funds are frequently actively managed, which can mean higher costs due to research, trading and portfolio management. However, index mutual funds are also widely available in the UK market.

Lower costs do not guarantee better performance, but over the long term, charges can have a significant impact on returns.

Example: a UK investor who put £50,000 into a fund charging 0.25% instead of 1.25% and earned a 5% annual return would have around £71,000 after 20 years rather than £62,000, purely due to lower ongoing costs.

Expense ratios

The term “expense ratio” refers to how much an investor will pay per annum, expressed as a percentage of the value of the fund. Generally speaking, ETFs, being passively managed, are relatively cheap. That being said, this is not always the case. It’s always worth checking it out before you commit yourself. 

In the short-term, actively managed mutual funds can perform better than ETFs, but that is not often the case in the long term. 

Given the higher expense ratio and the improbability of continually beating the market, actively managed mutuals often produce lower returns than ETFs over time.

Trading

ETFs are traded on an exchange throughout the trading day, allowing investors to buy or sell at prevailing market prices (just like stocks). This offers flexibility, but prices may fluctuate intraday.

Mutual funds, by contrast, are typically bought or sold at the end-of-day NAV. This can simplify investing for long-term savers who are less concerned with short-term price movements.

Trading costs are thus largely determined by the platform you use. Many UK brokers now offer commission-free ETF dealing, though this is a commercial feature rather than a regulatory standard.

Because ETFs trade like shares, investors should also consider the bid-ask spread, which represents an implicit cost of buying and selling and can be wider for less liquid ETFs.

Minimum Investment Requirements

Mutual funds  often have high entry costs and this also apply to target-dated mutuals, which are funds designed to help novices save towards specific ends (they often involve minimum investment sums of £1,000 or more). 

ETFs on the other hand, can be purchased by the individual share (and even fractions of shares), thereby reducing the cost of either establishing a position or maximising an already existing one.

Tax Treatment

ETF and mutual fund are basically taxed in the same way as other investments while ETFs are often considered slightly more tax-efficient in practice because their structure typically results in lower portfolio turnover and fewer realised capital gains within the fund. 

When held outside an ISA or pension, gains may be subject to Capital Gains Tax (CGT).

For the 2025/26 tax year, the UK Capital Gains Tax Annual Exempt Amount is £3,000. Gains above this level may be taxable, depending on your income tax band.

• Basic-rate taxpayers typically pay CGT at 10% on most investments
• Higher and additional-rate taxpayers typically pay CGT at 20%

The UK system does not distinguish between short-term and long-term capital gains based on how long an investment is held. Tax rates depend on income level, not holding period.

When comparing the ETF vs mutual fund options, you need to bear in mind that mutuals’ active management often means that stocks are bought and sold more frequently. Where this results in a profit, it incurs capital gains tax, and this is passed on to each investor with shares in that fund even though you might not have sold your shares.

Example: a UK higher-rate taxpayer holding an actively managed equity mutual fund outside an ISA could receive a £5,000 taxable capital gain distribution in a year due to portfolio turnover, triggering a £400 CGT bill (£2,000 taxable above the £3,000 allowance at 20%), even though no shares were sold.

Long-term implications

Whether you are considering ETFs or mutual funds, both can be good vehicles for investors. 

If your main priorities include lower expense ratios and greater flexibility in trading, then an ETF could be the right choice for you. However, if you are more concerned about paying commissions, premiums, or any other factors that might impact on the value of your shares, and you think you would benefit from help with managing them, then a mutual fund might be the better choice.

The ease of trading ETFs may also encourage more frequent buying and selling, which can negatively affect returns for some investors, while the less flexible trading structure of mutual funds can support a more disciplined, long-term approach.

Before arriving at a final decision, the most important thing you have to consider is the level of risk that you are willing to take. Depending on your knowledge of such matters, we would usually recommend talking to professional financial advisers before committing yourself to any specific financial product.

ETFs vs Mutual Funds, comparison table

Which option is right for you?

• ETFs may suit investors who value lower ongoing costs, flexibility and transparency.
• Mutual funds may be better for those who prefer professional oversight and a more hands-off approach, particularly where platform access and advice are important.

In practice, many UK investors hold both ETFs and mutual funds within diversified portfolios, often inside ISAs or pensions, depending on their goals, risk tolerance and time horizon.

Before investing, it is important to understand the risks involved and consider whether professional advice is appropriate.

Key takeaways

• ETFs and mutual funds both provide diversification, but differ in structure and trading
• ETFs are usually passively managed and traded on exchanges while mutual funds are often actively managed and priced once per day
• UK capital gains tax rules no longer distinguish between short- and long-term gains
• The £3,000 CGT allowance applies for the 2025/26 tax year
• ISAs and pensions can eliminate most tax differences in practice

FAQs