What is the difference between an ETF and a mutual fund?

Both pool money to buy a diversified basket of securities, and both can be actively managed or track an index. The mechanical differences are how they trade and how they handle taxes. An exchange-traded fund trades on an exchange throughout the day at a market price that can differ slightly from the value of its holdings. A mutual fund is bought and sold directly with the fund company at net asset value calculated once daily after the market closes, so the price you get is not known when you place the order.

The tax difference is the one with real money attached, and it only applies in taxable accounts. Mutual funds must distribute realized capital gains to shareholders annually, which means you can owe tax on gains you never chose to take, triggered by other investors redeeming or by the manager trading. ETFs use an in-kind creation and redemption mechanism that largely avoids generating those distributions, which makes them meaningfully more tax-efficient for taxable investing. Inside an IRA or 401(k) this advantage disappears entirely, since nothing is taxed until withdrawal.

Practical considerations beyond the structure. ETFs generally have no minimum investment beyond one share, and many brokers now offer fractional shares, while mutual funds often require a minimum of a few thousand dollars. Mutual funds accept automatic recurring investments in exact dollar amounts more easily, which suits payroll-driven contributions. ETFs carry a bid-ask spread as a small transaction cost, which is negligible on large well-traded funds and can matter on thin ones. The variable that dominates all of this over decades is the expense ratio, and a low-cost index fund in either wrapper will outperform an expensive one of the other type by a margin that dwarfs the structural differences.