It becomes essential to secure your future financially when you’re in your twenties. Thanks to the growing financial literacy and financial products in India, there is now a wide range of investment avenues for investors with varied risk-return profiles. Many investors generally get caught up in the confusion of ETFs vs. mutual funds.
What are ETFs and mutual funds?
Exchange Traded Funds (ETFs) consist of stocks, bonds, money market instruments, etc. So, they are a mashup of various securities put together at a certain proportion. If you buy the units of ETF funds, you proportionately invest your money into different streams.
Conversely, mutual funds are pools of investments created by different investors. A mutual fund invests in various asset classes, such as stocks of different sectors, bonds, currencies, commodities, or a mixture of these.
Differences between ETF and mutual fund
ETFs closely resemble mutual funds in the structure they maintain, the regulations they follow, and how the funds are managed. However, there are a set of significant differences between the two:
| Points | ETF | Mutual Funds |
| Approach of fund | They are passively managed since they mimic the index’s performance and usually track an index. | They are actively managed by professionals. |
| Fund management expenses & fees | Since they are passively managed, the associated expenses and fees are comparatively lower. | Since the fund is actively managed, the fund management expenses are higher. |
| Convenience of trade | ETFs are traded like shares in the stock market. Hence, they can be bought and sold at the investor’s convenience. | Mutual funds cannot be bought at any time. You must first request that the fund house allocate units. So, the convenience of trade is lower comparatively. |
| Prices | Live prices are available through the market and change every moment. | Day end’s closing price is used as NAV. |
| Commission | You need to pay a commission for unit buy and sale transactions. | There is no need to pay a commission. |
| Lock-in period | There is no minimum holding period for investment in an ETF. | The lock-in period usually ranges from 9 days to 3 years, depending on the type of mutual fund scheme. |
| Liquidity | Higher since they are traded like stocks. | Lower, since they are not freely traded. |
| Stock order | It is possible through ETF. | It is not allowed under mutual funds. |
| Theme-based investing | Theme-based investing is usually not possible since ETFs mimic the market index. | Theme-based investing can be an option only in stocks with a higher market cap, supplies of only mid-caps, stores based on the business cycle, etc. It is also possible in the case of mutual funds. |
| Diversification & ROI | ETFs are highly diversified. Thus, ROI is as per market return. | Mutual funds are diversified based on the theme they follow. Diversification can be into stocks, bonds, or hybrid instruments. Accordingly, the ROI varies according to its constituents. |
Why choose an ETF over a mutual fund?
The following features of ETFs will help you pick an ETF over a mutual fund:
- Investing in ETFs is more tax-efficient since they are treated like any equity investment scheme.
- ETFs tend to have more liquidity than mutual funds. Thus, holdings can be withdrawn at your convenience. Mutual funds take 3-4 business days to settle.
- It provides greater flexibility since the units are traded on the stock exchange daily, unlike mutual funds, for which an application is required first.
- There is no lock-in period. Thus, you would have complete control over your holdings.
- One single unit of ETF is like a mini portfolio consisting of diversified stocks.
- There is no minimum amount of investment. Also, fund management fees are lower.
- You may also consider investing in ETFs of different schemes and call your portfolio a Mutual Fund ETF.
Which one to opt for?
Compared to the associated cost, the requirement of lock-in, tax efficiency, and other benefits, investing in ETF could be a better option for millennial investors. In specific circumstances, mutual funds may be cheaper to buy. Still, the choice of investment should be decided considering your risk appetite and return expectations.
