Mutual Funds vs. ETF - Difference Between Mutual Funds and Exchange Traded Funds

Published On: 30-Jul-2020

When it comes to investing in equity markets, investors tend to prefer investing through mutual funds. Investors can invest in a wide range of mutual fund schemes, suiting their investment horizon, and risk appetite. One such investment option is the Exchange Traded Funds which is populary know as ETFs. Equity ETFs tracks an underlying equity index and the main difference between traditional mutual fund schemes and ETF is, ETFs can be traded on the stock exchange. 

A picture containing drawingDescription automatically generated

One should consider various apectes which are mentioned below in this article while making an investment decision .

Underlying

ETFs can be available on various underlying asset classes like Equity, Debt, Commodity, Currency etc. Among these, ETFs on Equity is quite popular. Availibility of such varied asset classeses in simple form of ETFs, helps in appropriate asset allocation and efficient rebalancing of portfolio. 

Mode of Investing

Investing in mutual fund schemes can be done online through website/ mobile apps, etc. or by physically visting the official Points of Acceptance of the mutual fund. On the other hand, generally ETFs can be bought and sold on the stock exchanges where they are listed and traded. For this, investors may approach the stock brokers where they hold their stock trading account. Additioanlly, one may also approach asset management companies for investing in ETFs subject to fulfilment of certain criterias. 

Basis of Transaction

In case of traditional mutual fund schemes transaction is processed at the end of the day applicable Net Asset Value (NAV). On the other hand, as ETFs are tradeable on the exchanges, it can be bought and sold, during trading hours, near to its indicative real-time NAV i.e. INAV. 

Let us understand this with an example. Let us assume particular index is currently trading at 10,000 points. During market hours it drops to 9,000 points and by the end of the day it closes at 12,000 points. In such case ETFs helps in taking advantage of this intraday drop and willing investor may buy ETFs at a price which may be near to 9,000 index points. On the other hand, if someone invest in a mutual fund scheme, the investment will be made at an NAV which may be closer to 12,000 index points.

Thus, ETFs gives the better control over investment decision. 

Total Expense Ratio (TER)

Generally, as Equity ETFs are passively managed, their total expense ratio i.e. TER is less as compared to actively managed schemes. As we all know, rupee saved is rupee earned. Lesser TER helps in cost saving and there by enahancing the earings i.e. returns of the scheme. 

Transaction Costs

In addition to TER, investor should also consider costs associated with the transactions. In case of traditional mutul fund schems, overall all costs are accounted in the NAV and generally investors may not pay any additional cost*. In case of ETFs, in addition to NAV, investors also need to pay for trading brokerage, liquidity cost, demat account charges etc. 

*With effect from 1st July 2020, stamp duty is levied on all the investment transactions in mutual funds at 0.005%. This stamp duty is collected in addition 

to the NAV and is applicable for both mutual funds as well as ETFs. 

Both mutual funds and ETFs aim to cater to the investment needs of the individual. However, the decision to invest in these products depends on the investors' specific investing needs. 

An investor may find mutual funds more suitable for the operational convenience of investing. On the other hand, ETFs can be more suitable if the investor wants to take benefit of intraday index movements at a lower cost (TER). 

The investors may make an informed decision regarding the suitability of the specific investment product in their financial plans.