Introduction

Maintaining your financial health is one of the most important tasks, especially from a future perspective. Thankfully, there are multiple options that help you ensure that your money generates lucrative returns as per your goals. Out of all the investment options available in India, Mutual Funds and ETFs are the most popular ones. These two investment options are preferred by most of the investors. 
 
Although both of these options seem similar at once, they have numerous differences. If you have questions regarding which option to choose, and which is better for generating high returns, then this article is for you. Here, we'll discuss everything about the ETF Vs Mutual Fund in detail! Let’s start by discussing the definitions of mutual funds and ETF

 

ETF vs. Mutual Funds: An Overview

One of the most difficult decisions an investor must make when making any investment is choosing an option out of an ETF or mutual funds. ETFs are often freely traded on the stock exchanges, allowing you to purchase or sell them according to your needs. The market price for these shares may be seen in real-time just like regular shares. On the other hand, you must submit a request to the relevant fund houses in order to acquire or sell mutual funds. Additionally, the NAV indicates their pricing. Active management of any kind is not necessary for ETFs. They function similarly to indexes. As a result, they have lower costs than mutual funds. However, the mutual funds are overseen directly by the fund.
 
Additionally, there are no commission fees associated with purchasing or selling mutual funds. However, because ETFs are exchanged like shares, you must pay fees when you trade them. ETFs do not, however, have a minimum lock-in period, so you are free to swap your shares whenever you choose without incurring any fees. Mutual funds, on the other hand, have holding periods that range from 90 days to 3 years. You will be subject to a severe fine if you purchase or sell shares during or before this period.

 

What is an ETF?

In a nutshell, an ETF is a collection of assets that you may purchase or sell on a stock market through a brokerage company. Almost any asset class imaginable, including traditional investments and so-called alternative assets like commodities or currencies, is available as an ETF. Innovative ETF designs also give investors access to leverage, market shorting, and tax-free short-term capital gains.
ETFs typically require a small minimum amount as an initial investment. Investors have to pay as less as the price of one share and the fees of the fund house. Further, these are created in comparatively larger lots by institutional investors. Also, the shares trade all day just like stocks. 
Similar to a stock, an ETF can also be sold short. However, this facility is great for spectaculars and traders but has no meaning for the long term investors. Because ETFs are continuously priced by the market, there is always a chance for trading to take place at a higher price than the actual NAV. 
 
Furthermore, ETFs offer many tax benefits to investors. But because they are passively managed funds, they realize less capital gains as compared to mutual funds. 

 

What are Mutual Funds?

A mutual fund is a type of financial instrument that combines money from investors to buy stocks, bonds, and other assets. Companies that are eligible to establish mutual funds establish Asset Management Companies (AMCs) or Fund Houses, which collect investor cash, promote mutual funds, handle investments, and facilitate investor transactions. Mutual funds might appear scary or confusing. We'll make an effort to make things as simple as possible for you. A mutual fund is essentially made up of the money that many different persons (or investors) have pooled together.
 
Mutual funds typically require a higher minimum investment than ETFs. Further, these minimum requirements can vary depending on the type of company and fund scheme. Most mutual funds are managed actively by an experienced fund manager or team that makes buying and selling decisions on the behalf of investors in order to provide them with higher returns. Such types of funds incur a higher cost as they require more effort, processing time, and expertise altogether. 
 
Moreover, the buying and selling of mutual funds happen directly between the fund and the investors. Also, the price of mutual funds is not determined until the NAV (Net Asset Value) is determined at the end of the business day. 
 

What is the difference between an ETF and a Mutual Fund?

Now that you've read about the detailed overview of mutual funds and ETFs, let's look at their key differences :
 

Basis

Mutual Funds

ETFs

Trading Value

Mutual funds are traded at the closing NAV (Net Asset Value)

ETFs are traded anytime during the trading day and their prices keep changing this time.

Operating Fees

Mutual funds have slightly higher operating fees. 

ETFs come with lower expenses. 

Minimum Investment Requirement

Mutual funds require a minimum investment. 

There are no minimum requirements in the case of ETFs.

Taxation

Mutual funds come with tax liabilities. 

ETFs offer multiple tax benefits to the investors because of the way of their redemption and creation.

Trading Mechanism

Mutual funds can be only purchased directly from the funds at their Net Asset Value which is fixed throughout the trading day.

ETFs can be purchased and sold anytime at their market price. 

Transaction Costs

When mutual funds are purchased or sold, they bear no transaction costs.

There are additional charges involved while trading ETFs at various stock exchanges. 

Liquidity

Mutual funds have lower liquidity, unlike ETFs.

ETFs come with higher liquidity because they do not involve daily trading volume. Their liquidity comes from the liquidity of the stocks. 

Selling Time Limit

Many mutual funds impose a penalty or fine on selling the shares before the fixed period. Usually, this time limit is levied on selling shares 90 days from the date of purchase.

On the other hand, ETFs do not have any specified buying or selling time. Investors can buy or sell them anytime they want. 

Management

Mutual funds are actively managed by expert fund managers or teams, but they are index-tracking as well. In this case, assets are chosen in a way that they achieve higher performance by beating the index. 

 

On the other hand, ETFs keep track of indexes. They try to match the returns as well as price movements shown in the index. 

 

 

Key benefits of ETFs 

Following are the key benefits of ETFs:

● Investors can buy ETFs on margin and also sell them short when needed. 
● Investors can buy as little as one share as there is no minimum investment requirement. 
● They can be purchased and sold at a price that varies throughout the business day. But the transactions can take place in real-time as well. 
● Cost is by far ETFs' largest benefit versus actively managed funds. ETF fee ratios can range from 1.5 to 2.25% below the actively managed fund expense ratios.
● ETFs operate similarly to other index funds in that unit subscription and redemption involve the exchange of underlying securities rather than cash 

 

Mutual Fund Vs ETF — Which Option to Choose?

Both investment options we have discussed above allow you to build an excellent investment portfolio and generate better returns. However, both have their own perks and drawbacks which should be kept in mind while picking anyone. The right selection depends entirely on your financial goals, experience levels, risk appetite and a few other factors. Before selecting the right option, ask yourself the following questions:

● What is your risk appetite? 

● What are your liquidity concerns? 

● What are your financial goals? 

● What is your investment horizon?

● Do you have any tax-saving strategies? 
 
After answering these questions, you will be able to decide what is the right option for you. Mutual funds may require you to stay invested for a longer period of time, but help you generate higher returns for the future. But if you need the flexibility of managing your funds and want to stay invested for a short-term, then an ETF can be a great option for you. The decision is completely yours, but you have to make it carefully for your own good. We hope this article will help you in selecting the right investment option. Also, if you want to become a smart investor and invest in a risk-free way, then visit 5Paisa! 

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