Although there is great consensus that family-based alternative care is the most appropriate caregiving environment for young children without parental care, institutions are still widely used in Chile. However, few studies have been conducted with samples of Chilean children in out-of-home care. The first aim of this study was to examine differences in the socio-emotional functioning of adopted and institution-reared children in Chile. Fifty-two adopted children were compared with 50 children living in institutions. Standardized interviews, questionnaires, and a structured task to assess the children’s psychological adjustment, attachment-related problems and assessment of family relationships were used. The results indicated that adopted children showed significantly higher levels of socio-emotional functioning than institution-reared children, with the majority of adopted children scoring within the normal range and the majority of institutionalized children showing clinical levels of emotional and behavioral problems. In addition, adopted children perceived better parenting quality than institution-reared children. The second aim of this study was to examine the influence of adoption related variables on the psychological adjustment of adopted children. In line with our expectations, factors associated with more positive outcomes among the adopted children were a younger age at adoption and living longer with their adoptive families. The results have implications for policy and practice in Chile when taking decisions in child protection.