ETFs (Exchange Traded Funds) and Mutual Funds are similar investment vehicles that provide the investors various features. Both have their benefits and shortcomings. ETFs are a good option for passive investors who want to invest in a particular Index or Sector without much rebalancing. On the other hand, Mutual Funds are a better option for active investors who are more active with their investments. One can switch between funds according to their current strategies.
ETFs and Mutual Funds are both investment vehicles that allow the investors to invest in certain asset classes directly or indirectly through them. ETFs and mutual funds collect money from the investors and invest that collected money towards the chosen securities. Let's understand both in detail.
Mutual Funds are an investment tool that collects money from the investors and buys securities with the collected money. As and when there is a gain or loss in those invested securities, it is passed on to the investors. Mutual funds are managed by a Fund manager who looks after the funds and makes all the buying and selling decisions to maximize the gains. For this, a small fee is charged from the investors in the form of an “Expense Ratio”.
ETF (Exchange Traded Funds)
ETFs are similar to mutual funds but with a twist. ETFs track the performance of an index, commodity, or a particular sector and gives the returns accordingly. ETFs are listed on stock exchanges which makes it easier to buy and sell at any given time within the market hours. ETFs are also managed by a Fund manager who makes sure that the ETF is accurately tracking the underlying.
1. Expense ratio
Mutual Funds charge more expense ratios compared to ETFs. Mutual funds incur a lot of costs and taxes for frequent buying and selling of securities. This leads to an increase in the expense ratio. ETFs are cheaper as they are mostly passively managed and don’t require frequent buying & selling.
2. Listed on Stock Exchanges
As the name suggests ETFs (Exchange Traded Funds) are listed on Stock exchanges whereas Mutual Funds are not. Due to this buying and selling ETFs become more convenient. One can place a limit order while buying and selling the ETFs which is not possible in Mutual Funds.
3. Price Change
The price of ETFs changes every second in the Secondary markets as they are listed. On the other hand, mutual fund houses update their NAV (Net Asset Value) only at the end of the day. This makes the buying and selling of ETFs more flexible.
As ETFs are listed on stock exchanges one can only buy and sell them on the exchanges. Sometimes the order volume can be huge and there might not be that many buyers or sellers to execute the order. This moves the price due to a lack of liquidity in ETFs. On the other hand, Mutual Funds provide ample liquidity. Mutual Fund always keeps a part of the total capital aside for redemption. Hence no price fluctuation takes place even while buying and selling extremely large quantities.
5. Minimum Investment
The minimum investment is a major difference when it comes to Mutual Funds and ETFs. ETFs are like equity shares where an individual can buy a minimum of 1 share. Whereas Mutual Funds allot units to their investors based on the money invested. Mutual Funds usually have a higher minimum investment amount ranging from Rs 100 to Rs 5000 in some cases.
6. Active and Passively managed funds
Mutual funds are mostly actively managed funds where there is a team of experts behind them. ETFs are considered to be passive funds as they track a particular index or sector hence too many changes are not required. Due to this ETFs offer a lower cost compared to Mutual Funds.
By the following points, it must be clear that both are similar to some extent. Some differences make both of the investment vehicles unique in their own way. An active investor can choose a Mutual Fund whereas a Passive investor could choose an Index ETF.