ETF vs Mutual Fund: Differences and Which Is Better

In the routine of work, earnings, spending and repetition, the crucial ingredient often missing from the narrative is investing. As individuals strive to achieve various life goals, the avenue of investment becomes important. Two widely discussed investment options in the financial landscape are Mutual Funds (MFs) and Exchange-Traded Funds (ETFs).

People approach investment, with diverse objectives like wealth creation, effective money management or building a robust retirement corpus. In this context, Mutual Funds and Exchange-Traded Funds have gained prominence as investment packages catering to different needs and preferences. In this blog, we will learn about ETFs and Mutual Funds and the best fit to make smart financial decisions. 

Understanding Mutual Funds

Mutual funds are a great way to invest money and grow it over time. These funds pool money from various investors and invest in a mix of stocks, bonds, or other securities. It is managed by professional fund managers so that you don’t have to take the stress. You can invest through Systematic Investment Plan (SIP) or lump sum and choose funds based on your risk level—low, medium, or high. They are ideal for long-term wealth building and come in various types like equity, debt, or hybrid, depending on your financial goals and time horizon.

Exchange Traded Funds (ETFs)

ETFs stand for Exchange Traded Funds, and these are investment funds that trade on stock exchanges like regular shares. They hold a basket of assets such as stocks, commodities, or bonds and usually track a specific index (like Nifty 50). With ETFs, you can get the flexibility of real-time trading, low expense ratios, and high transparency. They don’t require active fund management and are mostly passively managed. Investors who want stock market exposure at low cost often prefer ETFs. They are suitable for people comfortable with trading and want diversified investment options.

Equity Funds

Equity funds work like a basket that holds small pieces of ownership in many different companies. When you invest in Equity Funds, your money is used to buy shares or stocks of various companies. These companies could be big or small and as they grow and do well, your investment's value tends to increase.

Debt Funds

Unlike Equity Funds, Debt Funds involve lending money rather than owning a part of companies. When you invest in Debt Funds, your money is used to provide Loans to the government or companies. In return, you receive regular interest payments, like earning interest on a bank deposit. Debt Funds are generally considered less risky than Equity Funds, because the focus is on generating steady income through interest payments rather than relying on the fluctuations in the stock market.

Hybrid Funds

Hybrid Funds aim to strike a balance by combining the features of both Equity and Debt Funds. These Funds invest your money in a mix of Stocks (Equity), Bonds or other Debt Instruments. The idea is to provide the potential for growth through equity investments, while offering some stability through debt investments. Hybrid Funds cater to investors who want a diversified portfolio, benefitting from the potential returns of stocks, while having a safety net through fixed-income securities

Understanding Exchange-Traded Funds

ETFs and MFs involve collecting money from investors and investing it in various securities. The key difference lies in how they operate.

ETFs track an index, essentially a list of stocks from different companies based on that index. In contrast, MFs are managed by professionals who decide which securities to buy or sell. ETFs can be actively traded on stock exchanges, akin to individual stocks, providing real-time buying and selling flexibility.

This feature contrasts with Mutual Funds, where transactions occur at the end of the trading day at the Net Asset Value (NAV) price. Understanding these distinctions empowers investors to choose the investment vehicle that best aligns with their preferences and financial objectives.

Key Differences between ETFs and Mutual Funds

ETFs and MFs involve collecting money from investors and investing it in various securities. The key difference lies in how they operate.

1. Trading Mechanism

ETFs: Actively bought and sold on stock exchanges, offering flexibility similar to individual shares.

MFs: Purchased from a fund house, while some MFs are listed on exchanges, the buying and selling process differs.

2. Lock-in Period

ETFs: Typically do not have a minimum lock-in period, providing investors the freedom to buy or sell at their convenience.

MFs: Often involve a minimum lock-in period and selling before this period may incur penalties.

3. Management Style

ETFs: Passively managed, tracking the performance of a specific index.

MFs: Actively managed by Fund Managers or professionals who strategically allocate funds.

ETF vs Mutual Fund - A Table Comparison

Here is a detailed table for the difference between ETF and Mutual Fund

Benefits of ETFs

ETFs offer unique advantages that appeal to certain investors:

• Real-time Trading: ETFs can be traded throughout market hours, allowing investors to react to real-time market changes

• Lower Expenses: Generally have lower expense ratios than actively managed MFs due to passive management.

Benefits of Mutual Funds

Mutual Funds on the other hand, present a set of advantages that cater to different investor preferences:

• Active Management: Fund Managers actively make investment decisions, aiming for optimal returns.

• Diversification: Offers diversification across various securities to mitigate risks.

Similarities Between ETFs Vs Mutual Funds

Below are some key similarities between ETFs and a Mutual Fund:

1. ETFs and Mutual Funds mean investing in a mixture of stocks, bonds, or other assets.

2. Both of these are managed by fund professionals. By using these options, you can also invest with small amounts of money.

3. With both of these investment options, you can grow your wealth over time and spread risk by investing in multiple securities.

4. You can choose from different types, such as equity, debt, or hybrid funds, depending on your goals.

5. Both of these allow you to build long-term savings with the benefit of professional fund management and diversification.

Factors to Consider When Choosing Between ETFs and Mutual Funds

When you are confused between ETFs and Mutual Funds, consider these factors and choose the ideal option for you:

1. Mode of Investment

The first thing to know is that mutual funds can be purchased directly from the fund house or through your bank, and you can invest via SIP or lump sum. ETFs, on the other hand, are bought and sold on stock exchanges like shares.

2. Expense Ratio and Cost

ETFs come with lower expense ratios when compared to mutual funds since they are passively managed. Mutual funds, especially actively managed ones, may charge slightly higher fees. If cost-saving is a priority, ETFs may be more economical over time.

3. Liquidity and Real-Time Pricing

ETFs offer real-time pricing and can be traded anytime during market hours. Mutual funds are priced only once a day (NAV) after the market closes. If you prefer flexibility and market-based pricing, ETFs offer more liquidity.

4. Minimum Investment

Mutual Funds have a low entry barrier; some allow SIPs starting from ₹100. ETFs require you to buy at least one unit at market price, which can vary. So, mutual funds are often easier for beginners.

5. Tax Efficiency

ETFs may be more tax-efficient because of the way they are structured and traded. Mutual funds can have capital gains tax triggered more often due to portfolio changes by the fund manager.

Which Investment is Right for You?

When deciding between ETF and Mutual Funds, it is crucial to align choices with individual financial goals, risk tolerance and preferences for active or passive management. ETFs bring flexibility and real-time trading advantages, allowing investors to buy and sell throughout the trading day.

On the other hand, MFs provide the expertise of professional Fund Managers who actively manage portfolios, making strategic decisions to navigate market fluctuations. Understanding these distinctions empowers investors to make informed choices based on their unique financial objectives and preferences.

Conclusion

In the dynamic investment domain, Mutual and Exchange-Traded Funds play distinct roles. Investors must comprehend the nuances of each option to make informed decisions, aligned with their financial objectives. Choice between ETFs Mutual Funds depends on various factors and understanding these differences empowers individuals to make effective decisions.

FAQs

Can I invest in both ETFs and mutual funds?

Yes, you can invest in both. Many investors mix ETFs and mutual funds in their portfolios to balance flexibility, cost, and risk. It depends on your goals and comfort with managing investments.

Which is safer – ETF or mutual fund?

Both are safe if you choose reputed funds. ETFs are market-traded and can be volatile short term. Mutual funds are managed by professionals and may offer more stability. Your risk depends on the type of fund you pick.

Are ETFs better for short-term or long-term?

ETFs can be used for both, but they work best for long-term goals. Over time, they benefit from compounding and lower costs. However, experienced investors also use them for short-term trading due to real-time pricing.

Can I switch from a mutual fund to an ETF?

Yes, but it’s not a direct switch. You need to redeem your mutual fund and then use the proceeds to buy an ETF. Keep in mind, this may trigger capital gains tax.

What are the charges associated with ETFs and mutual funds?

Mutual funds may include expense ratios, entry/exit loads, and other management fees. ETFs have a lower expense ratio but include brokerage charges, demat fees, and Securities Transaction Tax (STT) while buying or selling.