Securing your financial future is very critical, and while there are several options available that will generate adequate returns, ETFs and mutual funds are the more popular ones. At a glance, both options look very similar but on close analysis, it can be found that both are different. The main difference between the two is that ETFs can be bought through a brokerage like stocks and not through a fund management company like mutual funds.
The choice between an ETF and a mutual fund is often based on the convenience of the buyer. If a buyer already has a brokerage account it becomes easy and convenient to buy an ETF and if they do not it is easier to opt from a mutual fund instead.
What is an Exchange-Traded Fund (ETF)?
An ETF is an investment fund that is traded on the stock exchange. The assets that are held under an ETF are commodities, stocks, and bonds. ETFs or Exchange Traded funds are passively managed funds that merely replicate an index. These funds usually hold all the stocks in the same weight as they are held by the underlying index. An ETF can be used for the purposes of hedging, equitising cash, and arbitrage. ETF shareholders get a part of the profits on the dividends paid and interest earned.
Here are a few advantages of ETFs:
Investors can sell short or buy on margin and as there are no minimum investment requirements; an investor can also purchase just one share.
The commission that is paid to the broker while buying or selling ETFs is the same that would be paid for a regular order.
It is similar to a mutual fund as it can be bought or sold at a cost that varies throughout the day. All transactions are carried out in real-time.
What are Mutual Funds?
Mutual Funds are professionally managed funds that collect money from various investors and then invest in diversified holdings. The investment portfolio includes bonds, money market instruments, stocks, or a combination of all. Each mutual fund investment scheme has a defined Net Asset Value (NAV) that is derived after dividing the total investment of a mutual fund by the number of investors. An investor owns a share of the mutual fund and incurs the same profits or losses as the rest of the investors.
Mutual Funds vs ETFs
ETFs are freely traded in the market, which means they can be bought or sold at the convenience of the investor. Their market price is available in real-time just like ordinary equity shares.
Mutual funds units can be bought or sold only by placing a request with the fund house. NAV indicates the price of one unit of a mutual fund.
2) Fees and expenses
ETFs just replicate the performance of an index. They do not need active management, which is why the fees and expenses associated with ETF investments are low.
In the case of mutual funds, the fund manager actively takes decisions on behalf of the investors. As a result, the fund management expenses are higher.
ETFs are traded like any other share on the exchange — investors need to pay commissions on the sale and purchase of units as per the prevailing rules.
In the case of mutual funds, there is no need to pay any commission for the sale and purchase.
Mutual funds are actively managed by an experienced fund manager who takes all the investment decisions on behalf of the investors.
In the case of ETFs, the funds merely track the market index. There are some actively managed ETFs, however, they have a higher expense ratio.
5) Lock-in period
ETFs do not have a minimum holding period, and the investors are free to sell the investment as and when they like.
Many mutual funds come with a lock-in period of 3 years. During this timeframe, it is not possible to liquidate the investment.
When it comes down to deciding which of the two options is best for you, it is imperative to consider 5 factors —risk-management appetite, ease to liquidate the assets, your financial goals, your tax-saving strategy, and investment horizons.
Once you have taken these factors into consideration, it will become evident to you which of the two investment options is more suitable.
ETFs offer you flexibility and higher returns in the short run. Mutual funds require investors to stay invested for an extended period of time to help create a corpus for the future.
Keywords: s, Mutual Funds, Financial Investments