As hard working individuals we like to believe that all this hard work will help us fetch some monetary gains in the future. However, the money we earn overtime, if we do not invest it appropriately then we might be able to improve our existing financial status. There are plenty of investment products out there available for investors, but the main problem lies in making an informed investment decision. People invest without having any clear perspective. This leaves them in a position where they do not know how and where to adequately invest.
If you carry some risk appetite and do not mind investing in market linked schemes to earn capital appreciation, you can consider investing in mutual funds. However, the problem that new investors face is they are confused about the several mutual fund categories and subcategories out there. Every mutual fund scheme carries a unique investment objective and asset allocation strategy yet finding the right scheme that suits your income needs can be exhausting.
Mutual funds and exchange traded funds are both favored by investors who have different investment needs. To understand the difference between these two we need to first understand them.
What is a mutual fund?
A mutual fund is a pool of professionally managed funds where the Asset Management Company pools financial resources from investors having a common investment objective and invests the capital raised across multiple asset classes and money market instruments. Mutual funds have an underlying portfolio of securities and the performance of a mutual fund scheme depends on the performance of these underlying assets and all the sectors / industries / commodities in which it invests.
What is an exchange traded fund?
Mutual funds are broadly categorized as actively managed funds and passively managed funds. Actively managed funds offer active risk management where the fund manager is constantly engaged in buy and selling securities to earn and profit from it. On the other hand, passive funds like exchange traded funds have fund managers but their role in running the fund is limited. Exchange traded funds (ETFs) are designed in such a way that they try to replicate the performance of their underlying benchmark with minimal tracking error.
Mutual funds v/s ETFs
|Parameter||Mutual funds||Exchange Traded Funds|
|Flexibility||Mutual fund units can be brought and sold by investors by placing a request to the AMC||Exchange traded funds can be bought and sold at their live NAV at the stock exchange pretty much like any other stock|
|Expense ratio||Since mutual funds are actively managed funds, they have a high expense ratio||Since there is very little participation of the fund manager who is involved in evaluating and reshuffling the portfolio, ETFs carry a low expense ratio|
|Commission||There are no commission involved when buying and selling mutual fund units||Since ETF units are traded live at the exchange behind each transaction there is a commission fee involved|
|Demat account||One doesn’t need a demat account to buy or sell their mutual fund units||One cannot trade with ETF units unless they set up a demat account|
|Lock-in period||Except ELSS that has a 3 year lock-in period, mutual funds do not have any lock-in period||ETFs do not have any lock-in period|
It is really hard to determine whether which out of the two offer better returns. However, mutual funds like equity funds have known to offer risk adjusted returns over the long term. Investors who are good with trading may be able to buy and sell ETF units during live trading hours and generate capital appreciation. However, there is a high risk involved with both mutual funds and ETFs and retail investors must seek professional help if necessary.