Mutual Fund vs. ETF : Which is Right for You?

The idea of pooled fund investment is the foundation for both mutual funds and exchange-traded funds (ETFs). An indexed passive approach has been followed frequently that attempts to mimic or follow benchmark indexes that are reflective of the market. Mutual funds are exchanged after market hours and valued at the net asset value once a day. ETFs are traded on stock exchanges all day long, just like regular equities. Because ETFs are more passive, they often have lower cost ratios and are more tax-efficient overall.

Geeky Takeaways:

• Pooled fund investment is the foundation for both mutual funds and exchange-traded funds (ETFs).
• Mutual funds are collections of capital from several investors with a single, shared investment goal. Professional fund managers of the mutual funds then invest the money collected under the scheme.
• ETFs, or exchange-traded funds, are financial vehicles that are much like any other securities in that they can be readily exchanged on a stock market.
• The main benefits of the pooled fund idea are economies of scale and diversity. By utilizing pooled investment funds for large-lot share transactions, managers may lower transaction costs.

What are Mutual Funds?

Mutual funds are collections of capital from several investors with a single, shared investment goal. Professional fund managers of the mutual funds then invest the money collected under the scheme which is often operated by an asset management company in stocks, bonds, money market instruments, and other assets. Each investor receives “units,” or portions of the fund, according to the amount they have invested. By determining the net asset value, or NAV, the income from the program is disbursed among all participants according to their investment.

How do Mutual Funds Work?

Mutual funds (MFs) are investment vehicles that pool money from multiple investors to invest in a diversified portfolio of securities such as stocks, bonds, money market instruments, or a combination of these assets.

1. Pooling of Funds: Investors buy shares or units of the mutual fund, and their money is pooled together with that of other investors. This pooled money is managed by professional fund managers.

2. Diversification: The pooled money is invested across a diversified portfolio of securities. This diversification helps spread risk because if one investment underperforms, gains from other investments may offset the losses.

3. Professional Management: Mutual funds are managed by experienced and knowledgeable fund managers who make investment decisions on behalf of the investors. These managers analyze market trends, economic conditions, and individual securities to make informed investment choices.

4. Investment Objectives: Each mutual fund has specific investment objectives, such as growth, income, or capital preservation. These objectives determine the types of securities the fund invests in.

5. Net Asset Value (NAV): The NAV of a mutual fund represents the per-share or per-unit value of the fund’s assets minus its liabilities. It is calculated at the end of each trading day based on the closing prices of the securities in the fund’s portfolio.

6. Buying and Selling: Investors can buy or sell shares or units of a mutual fund at the current NAV. The price at which shares are bought or sold may be subject to fees or charges, such as sales loads or redemption fees.

7. Costs and Fees: Mutual funds may charge fees such as expense ratios (for managing the fund), sales loads (commission for buying or selling shares), and redemption fees (for selling shares within a certain time frame).

8. Distribution of Profits: Mutual funds may distribute profits to investors in the form of dividends or capital gains. These distributions can be reinvested in the fund or paid out to investors in cash.

Types of Mutual Funds

1. Based on Asset Class: On the basis of asset class, mutual funds are categorised into various subdivisions including Equity Mutual Funds, Debt Schemes Mutual Funds, Hybrid Schemes Mutual Funds, and Money Market Funds.

2. Based on Investment Goals: On the basis of investment goals, mutual fund has been defined as Income Funds.

3. Based on the Maturity Period: Open Ended Funds, Closed Ended Mutual Funds, and Interval Funds has been defined as types of mutual funds on the basis of maturity period.

4. Sector Mutual Funds: Sectoral mutual funds include Index Funds, Global Mutual Funds, International Mutual Funds, Real Estate Funds, Multi-Asset Allocation Fun, and Exchange Traded Funds (ETF).

5. Additional Funds: Some other funds include Commodity Mutual Fund and Hedge Funds.

For a detailed explanation of all types of Mutual Funds, refer Types of Mutual Funds

Benefits of Investing in Mutual Funds

1. Diversification: Mutual funds pool the capital of several participants to purchase a variety of securities, such as bonds, stocks, or a mix of both. By distributing risk among several assets and lessening the effect of volatility on any one of them, this rapid diversification lowers risk.

2. Professional Management: The fund is actively managed by knowledgeable fund managers who choose and adjust investments in accordance with the goals of the fund and the state of the market. It is no longer necessary for individual investors to research and evaluate a wide range of options.

3. Convenience: Investing and managing money are made easy with mutual funds. Using online platforms, investors may easily manage their assets, make monthly contributions with little effort, and choose from a variety of funds depending on their financial goals and risk tolerance.

4. Reduced Expenses: Purchasing individual stocks frequently results in large transaction costs, such as equity brokerage, stamp duty, exchange transaction charge, SEBI turnover charge, DP charge, and investor protection fund trust charge. Because of economies of scale, mutual funds provide investors with access to a diversified portfolio at a fraction of the price of individual investments.

5. Liquidity: The majority of mutual funds have a high level of liquidity, making it simple for investors to sell their shares and get fast access to their money in an emergency. This adaptability is useful in the event of unanticipated costs or shifting financial conditions.

Risks of Mutual Funds

1. Market Risk: Overall market swings can still affect mutual funds. Major market downturns can negatively impact the value of a fund, even with diversification.

2. Investment Risk: If the fund manager’s recommended investments underperform, investors might lose money. Thorough investigation and comprehension of the fund’s assets and strategy are essential.

3. Management Risk: The success of a fund can be greatly impacted by the knowledge and judgment of its management. Selecting a fund with respectable management and a track record of success is crucial.

4. Costs and Expenses: Mutual funds impose a number of costs, such as transaction fees and expense ratios, which over time may lower returns. To maximize investment results, it is essential to compare fees and select low-cost funds. Your overall fund returns will be lowered if you invest in a fund with a high cost ratio.

5. Tax Repercussions: Depending on the kind of fund and investment income, capital gains taxes may be imposed when selling mutual fund shares. The easiest way to comprehend the tax ramifications of investing in mutual funds is to speak with a tax advisor.

How do I invest in Mutual Funds?

1. Asset Management Companies (AMCs): To invest in a mutual fund scheme, investors can get in touch with AMCs right away. AMCs offer application forms that must be completed with the required data and submitted with the investment amount. You have three options for making payments: demand draft, online, or check. The mutual funds that are offered include SBI, ICICI Prudential, HDFC, and UTI.

2. Online Platforms: Investing in mutual funds is made easier by a number of online platforms and brokerages. These systems provide an easy-to-use interface, monthly browsing, and the ability to select the finest mutual funds based on risk tolerance and financing objectives. The investing procedure is easy and transparent for investors because it can be finished online. Online platforms for mutual funds available in India include Groww, Zerodha, and Upstox.

3. Systematic Investment Plans (SIPs): Instead of making a single, lump-sum commitment, SIPs enable investors to make regular, monthly, quarterly, and other interval investments. With time, this method lessens the impact of market volatility by averaging the investment value.

4. Systematic Withdrawal Plans (SWPs): SWPs allow investors to take a predetermined amount out of their mutual fund assets on a regular basis. This is suitable for people who need to keep the majority of their investments while receiving a consistent income stream from them.

What are Exchange-Traded Funds (ETFs)?

ETFs, or exchange-traded funds, are financial vehicles that are much like any other securities in that they can be readily exchanged on a stock market. ETFs combine the stocks of the listed firm with mutual funds. In other words, ETFs are collections of many security classes that provide the flexibility and diversification of equities (stocks). To put it simply, exchange-traded funds, or ETFs, are collections of stocks, bonds, debentures, and other assets that may be freely exchanged on a stock market. ETFs are made and intended to follow a certain sector or market index. Currently, a number of exchange-traded funds (ETFs) are based on broad-market, sector-specific, asset-class-specific, and country-specific indexes.

How do ETFs work?

1. Creating ETFs: An “authorized participant” (AP) assembles a diverse asset portfolio and then monitors the index performance that ETFs seek to match.

2. Listing and Trading: After an ETF is established, it is split up into shares that may be freely traded like any other stock and listed on a stock market. An investor in an ETF only purchases a share; they do not get any ownership rights over the fund’s underlying assets.

3. Pricing: The management of an exchange-traded fund (ETF) constantly quotes bids, replicates ETF prices, and makes sure that ETF prices stay in line with the Net Asset Value (NAV) of the underlying assets.

4. Tracking Performance: To accurately reflect the performance of the underlying sector or index that the ETFs are intended to follow, investing managers regularly assess the ETFs’ performance. ETFs are promptly modified to reflect the changes.

5. Fees: Investment managers of exchange-traded funds (ETFs) charge a fee for their services in the form of management fees, administrative fees, and other operational charges, much like managers of mutual funds do. These expenses, however, are less than what mutual fund managers charge.

6. Purchasing and Selling: Investors are free to purchase and sell ETF shares on a stock exchange at current market prices after making an investment and obtaining a share. These prices, which are based on market supply and demand, are probably not the same as the NAV of the fund’s underlying assets.

Types of ETFs

ETFs are designed to replicate the performance of several indexes or sectors. They may be categorized into the following kinds based on the underlying assets, investing techniques, and sector:

1. Equity ETFs: Equity ETFs are exchange-traded funds that invest in the shares of firms that are listed on a stock exchange. These exchange-traded funds (ETFs) monitor the performance of various market capitalizations, geographic areas, and industrial sectors, including small-, mid-, and large-cap.

2. Fixed Income ETFs: These ETFs concentrate on all varieties of assets with fixed income yields, such as bonds and debentures. It makes investments in various kinds of bonds, such as agency, municipal, treasury, corporate, and government bonds.

3. Commodity Exchange-Traded Funds (ETFs): These funds invest in firms engaged in the production, development, or distribution of physical commodities, such as gold, silver, oil, or agricultural goods, with the goal of tracking the price fluctuations of the underlying commodity. ETFs that track commodities offer diversification or a buffer against other economic conditions, such as inflation.

4. Currency ETFs: These enable investors to participate in the foreign currency market by investing in and concentrating on a variety of currencies from various nations. These exchange-traded funds (ETFs) monitor the performance of particular currencies, currency pairings, or offer exposure to a currency basket.

5. Real Estate ETFs: These funds are invested in actual real estate, real estate operating companies (REOCs), or real estate investment trusts (REITs) that manage or own assets that generate revenue from real estate. Investors can follow the performance of particular property categories, such as residential, commercial, or industrial real estate, and increase their exposure to the real estate market through these exchange-traded funds (ETFs).

6. Factor ETFs: In order to provide exposure to certain investment strategies, factor ETFs concentrate on various investing aspects such as value, financial objective, risk management, timeframe, growth, etc.

7. Multi-Asset ETFs: These exchange-traded funds (ETFs) leverage the advantages of a diversified investment strategy into a single fund by investing in a diversified portfolio made up of assets of various classes bundled together.

8. Sector ETFs: ETFs that invest in certain industries or sectors, such as consumer goods, renewable energy, healthcare, technology, or finance.

Benefits of Investing in ETFs

1. Diversification: ETFs are essentially a collection of many asset types bundled into a single vehicle. This makes it possible for investors to reap the rewards of diversified investing all at once. Investors are better able to manage the risk element related to the financial market thanks to ETFs’ diversified nature.

2. Cost-Effective: Investors are taking notice of exchange-traded funds (ETFs) due to their lower management costs as compared to mutual funds. ETFs monitor an underlying index that may be managed passively and inexpensively; they are freely traded on stock exchanges.

3. Transparency: At the conclusion of each trading day, exchange-traded funds (ETFs) provide investors with access to a detailed overview of their holdings as well as an index of the underlying assets. This facilitates the tracking and monitoring of ETF performance. This helps when deciding what to invest in.

4. Flexibility: ETFs are a highly liquid financial tool since they are listed on a stock exchange and are simple for investors to buy and sell at any time. Additionally, investors may benefit from liquidity’s flexibility and simplicity by adjusting their holdings in accordance with the shifting goals of their investments or market circumstances.

5. Tax Benefits: Compared to other investment funds, exchange-traded funds (ETFs) are thought to be tax-efficient due to their low portfolio turnover and low capital gain generation. In addition, selling shares in a way that avoids paying hefty taxes on short-term capital gains is made simple by investing in exchange-traded funds (ETFs).

Risks of ETFs

1. Market Risk: Because ETFs are investment funds, they are vulnerable to market risk. This implies that any alteration in the state of the market has an immediate impact on the ETFs’ market value. Investors lose money when a market index or sector performs poorly because it negatively impacts the value of exchange-traded funds (ETFs) in that sector.

2. Liquidity Risk: Despite the claim that exchange-traded funds (ETFs) are freely traded, trading volume and market activity affect how liquid an ETF is. Low-trading-volume ETFs are challenging to sell at the right prices, particularly during a market decline.

3. Tracking Error: Although exchange-traded funds (ETFs) are intended to monitor the performance of many indexes, the actual performance of the ETFs’ indexes differs somewhat from that of the benchmark. Such a performance divergence might undermine investors’ return expectations.

4. Interest Rate Risk: Although an exchange-traded fund (ETF) investment in fixed-income assets yields a fixed interest rate over a predetermined length of time, it also carries interest rate risk. Investors lose money when the market value of these ETFs declines due to an increase in the interest rate on such assets.

5. Tax Risks: Because ETFs are taxable, investors may have to pay more in taxes overall. In the event that the ETFs generate substantial capital gains, the investor’s burden increases. Furthermore, even if ETF shares are not sold, investors are still responsible for paying taxes due to the rapid portfolio turnover in ETFs.

How do I invest in ETFs?

1. Determining Financial Objectives: Identifying the investor’s financial objectives in terms of return, time horizon, and risk tolerance is the first stage in any investing process. This aids in choosing the appropriate ETFs based on the investor’s objectives and risk tolerance.

2. Choosing a Broker and Opening an Account: To trade in exchange-traded funds (ETFs), an investor must first choose which brokerage business to use—online or offline—after deciding on their objectives and the underlying assets. For this reason, elements including commissions, fees, trading tools, and customer support are taken into account.

3. Trading ETFs: After funding the brokerage account, the investor can purchase ETF shares using the platform or brokerage company. The investor must specify the kind of ETFs, the quantity of shares in the ETFs, the market order, and the money to be invested. It is usually preferable to go over every aspect before finalizing the investment.

4. Monitoring and Managing ETFs: Following an investment in ETFs, it is important to conduct routine monitoring and management of the ETFs. At the conclusion of the trading day, the ETF Company provides a comprehensive report that simplifies investment management by outlining the ETF holding and the value of the underlying assets.

5. Seeking Expert Assistance: To obtain the intended return, exchange-traded funds (ETFs) are susceptible to market risk and so require expert management. The knowledgeable managers recommend appropriate ETFs based on the investors’ objectives.

Difference between Mutual Funds and ETFs

Basis	Mutual Funds	ETFs
Mode of Transaction	Direct purchases or sales of mutual funds are possible via the AMC or other approved middlemen.	ETFs are available for buy and sale on stock markets. Throughout the trading day, you are able to do so at the current market price.
Expense Ratio	The expense ratio of mutual funds is greater than that of ETFs.	ETFs have a lower expense ratio as compared to MFs.
Lock In Period	Open ended mutual funds don’t have any lock in period, however, close ended and ELSS have a lock in period.	There is no lock-in period for ETFs.
Liquidity	MFs are not as liquid as ETFs, mutual funds are nonetheless available.	Exchange-traded funds, or ETFs, have greater liquidity than mutual funds.
Exit Load	If you redeem units from a mutual fund before a certain period, you could have to pay an exit load, as stated in the fund’s factsheet.	There aren’t any exit loads for ETFs.
Investment Style	The majority of mutual funds have an active investing mentality.	ETFs use a passive approach, and due to this reason the expense ratio is generally less.

Mutual Funds or ETFs? Which is Right for you?

1. An Appetite for Risk: Mutual funds are an option if you can withstand market volatility and have a high tolerance for risk. ETFs, on the other hand, are an option if you want your fund to mimic the index it is monitoring.

2. Budgetary Objectives: Mutual funds are a good choice for long-term objectives that call for investments in inflation-beating securities, such as retirement or your children’s further education. ETFs, on the other hand, are a superior option if you wish to profit from brief price swings.

3. Horizon of Investment: This is yet another important factor to take into account. Mutual funds are a better option than exchange-traded funds (ETFs) if you have a lengthy investing horizon since they may yield higher returns. However, if your investing horizon is short-term, you can prefer ETFs.

Conclusion

The majority of mutual funds are actively managed, while index funds with passive management have gained popularity recently. ETFs typically follow a market index or a sector sub-index and are passively managed. Unlike mutual funds, which may only be acquired at the end of each trading day, exchange-traded funds (ETFs) can be bought and sold exactly like stocks. ETFs and mutual funds both assist you in investing in equities from a variety of firms and creating a diversified portfolio. The aforementioned criteria must serve as your guidance while making an investment. You can strengthen your portfolio and stay on track to reach financial freedom by having a good balance of both.

Mutual Fund vs. ETF – FAQs

Are ETFs exempt from taxes?

Selling an ETF less than a year later results in a short-term capital gain that is subject to taxation. Holding ETFs for more than a year is subject to long-term gains tax.

Are ETFs superior to mutual funds?

Commodities, bonds, and equities can be held via mutual funds and ETFs. Both have the ability to track indices, but because ETFs trade on exchanges like shares of stock, they are often more affordable and liquid. Mutual funds only permit trades once a day and can provide more expensive active management and regulatory monitoring.

Do ETFs carry a risk?

ETFs carry far greater risk when investing than index funds do.

Is it possible for an investor to make a SIP?

While trading in ETFs, an investor cannot use SIP to invest in index funds. However, they may do so in index funds.

Which type of investing spreads the risk for the investor?

Compared to ETFs, an index fund diversifies the investor’s risk