The difference between ETF and mutual funds

After completing her MBA last year, Pranjali received a job offer from a major Pharmaceutical company. She was delighted by the offer and started her career. Upon earning her first salary, which was much higher than she could imagine spending in a month, she began considering ways to utilise it optimally. She had seen many of her friends struggling with credit card bills and other debt, following excessive spending and that was not a part of her future plan. After some research, Pranjali landed upon the inspired idea of investing a part of her salary every month. This would enable her to build an emergency fund while also helping her plan for her financial independence. She had read about two terms which seemed interesting – mutual funds and ETFs. The question then came to ETF vs mutual fund, and the option she should pursue.   

What are ETFs?

ETFs or exchange traded funds are a type of passive mutual fund schemes which are traded on exchanges. In that aspect, they are similar to stocks. Given that ETFs are traded on exchanges, they are more liquid than non-ETF schemes. Since ETFs are passive funds, they do not have an active fund manager helming the portfolios. This ensures that their fee is lower than that of active mutual funds. ETFs track almost all kinds of indices, from stocks, and commodities to fixed income. A variety of ETFs are available for investment today, and the instrument is offered by most major fund houses in India.

Difference between ETF and mutual funds

While you now know what ETFs are, let us understand the features of mutual funds. Professionally managed investment vehicles funded by a wide range of unit-holders, mutual funds will provide you the option to invest your money in such a way that you can achieve many of your financial goals. Mutual funds can broadly be classified into debt funds, equity funds and hybrid funds, on the basis of their holdings. Further, mutual funds are also categorised as active and passive funds, according to their nature of management. Therefore, ETFs, which are a form of passive funds, are actually a type of mutual funds and not a separate entity in itself. The difference between ETF and mutual funds can be decoded only when we zero in on a particular type of mutual fund because, otherwise, ETFs are just a subset of the larger mutual fund category.

Which is better – ETF or mutual fund?

Now that you know the distinction, the next step would be to identify the ETF that is most suited for you. This is where it would be interesting to understand the advantages of investing in ETFs.

• One of the major advantages of ETFs revolves around the fact that these schemes charge a lower commission. Through ETF investments, you will be able to ensure that almost all of your money is being parked in the scheme’s units, rather than being paid as commission.
• Further, ETFs, since they track exchanges, are more transparent than other mutual funds, meaning that you can keep an eye on your holdings without needing to contact the fund house.
• In terms of the tax aspect, an investment in ETFs would lead to lower capital gains tax owing to structural differences between ETFs and other mutual fund schemes.
• If you are a beginner investor then equity ETFs can provide the necessary equity exposure while mitigating the risk associated with equities.
• If you are a seasoned investor, then ETFs can offer diversification since you have the option to invest in both equity as well as debt ETFs.

In summary, ETFs can be a great addition to your investment portfolio. However, the decision to invest should be based on your risk profile, investment goals, and return requirements. Once you have an idea about your risk appetite and return requirements, you can easily choose between ETFs and other mutual fund schemes. Now that you know the differences between the two investment options, you can take your pick and begin investing right away.

An investor education initiative by Edelweiss Mutual Fund

All Mutual Fund Investors have to go through a one-time KYC process. Investors should deal only with Registered Mutual Fund (RMF). For more info on KYC, RMF and procedure to lodge/redress any complaints, visit - https://www.edelweissmf.com/kyc-norms

MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS. READ ALL SCHEME-RELATED DOCUMENTS CAREFULLY