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 the varied risk-return profile of investors. Many investors generally get caught up in the ETF vs mutual funds confusion.
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 are proportionately investing your money into different streams.
On the other hand, mutual funds are a pool of investments created by different investors. A mutual fund invests in various asset classes such as stocks of different sectors, bonds, currencies, commodities, or maybe a mixture of these.
Differences between ETF and mutual fund
ETFs closely resemble mutual funds in the structure they maintain, regulations they follow, and how the funds are managed. However, there are a set of significant differences between the two:
|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 expenses and fees associated 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 anytime. You are first required to place a request with the fund house to 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 commission for buy and sale transactions of units.||There is no need to pay commission.|
|Lock-in period||There is no minimum holding period for investment in an ETF.||Usually, the lock-in period goes from 9 days to 3 years. The variation depends 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, or supplies of only mid-caps, stores based on the business cycle, etc. Theme-based investing is possible in the case of mutual funds.|
|Diversification & ROI||ETFs are highly diversified. Thus, ROI is as per market return.||Mutual funds are diversified on the theme they follow. Diversification can be either into stocks or bonds, or hybrid instruments. Accordingly, the ROI varies as per 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.