ETFs vs. Mutual Funds: Why You Should Consider ETFs from the Start

When you're getting started with investing, it can be overwhelming to sort through all the options. Mutual funds have long been the default choice for beginners, but that’s changing. Exchange-Traded Funds (ETFs) offer a smart, accessible, and often more efficient alternative.

Let’s explore why ETFs may be the right choice for building your portfolio.

Mutual Funds: Simple, but With Some Hidden Costs

Mutual funds are popular with investors because they’re simple. You invest in a managed basket of stocks or bonds and everything else is taken care of for you.

But mutual funds come with some downsides, especially as your investments grow. One of the biggest? Taxes. Mutual funds frequently generate capital gains distributions, even if you haven’t sold anything. That means you could owe taxes just because the fund made trades throughout the year. While they’re a great entry point, mutual funds can become less efficient over time.

Mutual funds with a load (commission) purchased through a broker or registered representative carry additional fees that are best to be avoided.

ETFs: More Tax-Efficient and Just as Easy

ETFs offer many of the same benefits as mutual funds like diversification, but with greater tax efficiency. ETFs rarely distribute capital gains, which means fewer unexpected taxable events. Over the years, that can add up to significant savings.

And while ETFs used to require full-share purchases, that’s no longer the case. Platforms like Vanguard, Fidelity, and others now allow fractional share purchases, making ETFs as accessible as mutual funds. You can start small and still build a diversified portfolio.

It’s important to note that the tax-efficiency of ETFs is most important to manage in taxable accounts. Mutual fund distributions in tax-protected retirement accounts like IRAs or 401ks don’t trigger the same type of taxable event as a non-retirement account. Savvy investors may use ETFs in taxable accounts and mutual funds in tax-protected accounts.

Building a Portfolio with Real Guidance

Unlike mutual funds, which often come in all-in-one packages like target-date funds, ETFs usually require you to select a few different funds to build a well-rounded portfolio. That’s not necessarily a bad thing, but it can feel intimidating at first.

Some investors turn to online robo-advisors to simplify this step. While convenient, robo-advisors use cookie-cutter strategies that don’t account for your unique goals or tax situation. They lack the personalized touch and can leave you in a portfolio that is generic and overpriced.

Instead, consider consulting a fee-only CFP professional as needed, even just for a session or two. A good advisor can help you choose the right mix of ETFs based on your goals, comfort with risk, and time horizon. This approach gives you guidance without giving up control.

A Quick Word on Trading ETFs: Use Limit Orders

Because ETFs trade during the day like stocks, the price can fluctuate from moment to moment. If you place a market order, you might pay more or sell for less than you expected, especially in a fast-moving market.

That’s why it’s smart to use a limit order. A limit order lets you set the maximum price you're willing to pay (or the minimum price you’ll accept if selling). It protects you from surprises and ensures you’re getting reasonable trade quality.

The Bottom Line: ETFs Belong in Your Portfolio

While mutual funds are easy and familiar, ETFs offer better tax efficiency and thanks to fractional shares, just as much accessibility. For investors starting their investment journey, ETFs are a smart starting point.

The key is that you don’t have to go it alone. With the right guidance from a fee-only advisor or a bit of upfront education you can confidently build a simple, strong ETF portfolio that grows with you.