ETF Vs Mutual Fund Differences Which One Should You Choose

Mutual funds and ETFs are the most common investment instruments. What is ETF vs Mutual fund Differences? Which one should you choose? 

ETFs and  Mutual funds are the cornerstones of people's financial planning, According to  Assets Under Management (AUM) 53.40 lakh crore is the amount Indians invest in mutual funds and ETFs. 

Both ETF and Mutual Funds work by pooling money from many investors and investing it to buy a mix of bonds, stocks, and other investments. Investors own small pieces of hundreds of thousands of different investments. Both these elements help diversification as the investor doesn't have to worry about picking up the stocks and then investing in them.

But even though there are multiple similarities in both these instruments, there are some major differences too. Mutual funds are not traded in the stock exchange. However, ETFs are traded in the stock market. ETF charges lower fees as well as provides trading flexibility

Mutual funds are professionally managed and come with stronger regulations, making them safer and easier to handle. Knowing these differences can help you choose the right investment for your financial goals. 

What Are Mutual Funds?

It's crucial for you to understand the workings of mutual funds before we talk about Exchange-traded Funds ETF.

Mutual funds are investment vehicles where a pool of funds is managed by a professional fund manager. These managers actively manage the mutual funds, aiming to make decisions that outperform the market. They allocate the funds across a diversified portfolio of assets, including stocks, bonds, and other securities. The objective of mutual funds can be either income generation capital appreciation or both.

How Does A Mutual Fund Work?

Investors get the units of the funds at the fund's Net Asset Value ( NAV). NAV is calculated after assessing the value of the underlying asset and deducting the expenses. Mutual funds are always priced at the end of the day.

Advantages of Mutual Funds

Mutual funds have the following advantages. 

• Professional management - mutual funds are managed by professional fund managers and hence the investors can rely on them. 
• Diversification- The funds are diversified into various asset classes or in various sectors hence minimising the risk
• Easy investment- Mutual Funds are easy to invest for both beginners or experienced investors.

What Are Exchange Traded Funds ETF?

As the name suggests ETFs are the pool of funds traded on stock exchanges just like other stocks. In most cases, they follow the movements of the indexes be it Nifty50 or Sensex.

ETFs make it easy for investors as they are able to acquire a wide range of assets, such as stocks, bonds, commodities, or other investments. This results in instant diversification and
Risk reduction.

ETFs are traded throughout the day on the exchange, whereas a mutual fund is brought and sold at the end of the trading day at the price calculated on the net asset value. Thus, ETFs give investors greater flexibility and control over when to buy and sell shares. Since ETF gives cost-effective market exposure with the diversification benefits of mutual funds. This makes ETF one of the most popular investment instruments.

The above graph shows the increase in the popularity of ETFs from the time of its introduction in the global markets. The ETF assets have grown from rs. 26,139 crore in FY2016-17 to rs. 6.95 lakh crore in recent times, with a significant rise in retail investor accounts from 5.33 lakh in 2017 to 1.25 crore in 2023.  

In most cases, ETFs are passively managed thus ETFs are cheaper than mutual funds. Since buyers and sellers are doing business with each other managers have much less to do. 

Following is the table showing statistical data about the scope of the ETFs.

How To Choose An ETF For Investing?

An investor must ask himself this one question before investing in ETF  - What is My Investment Plan? 

You must create an investment plan before investing in any financial instrument. 

• Make sure you are aware of your financial goals
• Compare your current investment portfolio with your goals
• Estimate your risk tolerance

Selecting an ETF 

One must keep the following points in mind before choosing to invest in ETF.

1. Fund Size 

Are you also confused about whether you should invest in an ETF with a small fund size or a large one?

There are no specific rules about this. However, an ETF with a larger fund size shows investors' interest and hence it may have higher liquidity. The cost of the larger funds ETF will always be less than that of small funds ETF. Hence it is advisable to invest in ETFs with larger fund size.

2. Age of ETFs 

 ETFs have been in Indian markets for about 2 decades. Every year new ETFs are launched to cater various needs of investors. However, just like new funds new ETFs don't have any previous record. Thus, you can't predict its performance. It will be wise if you choose to invest in an ETF that has at least 10 years past data.

3. Trading volume 

 The major ETF vs Mutual Fund Difference is that ETF units are bought and sold on the stock exchange. Hence it is important that the ETF is in demand.

4.Cost 

The cost of ETFs is less than that of Mutual Funds. This is because the ETFs are passively managed and hence the expense ratio is lower than the actively managed funds.

5. Tracking Error 

When an ETF tracks a specific index, the fund manager aims to build the portfolio in a way that the fund's returns closely match those of the underlying index. However, as the fund manager may not invest in all the securities comprising the index, there is a potential for a difference between the returns of the ETF and those of the index.

Hence an ETF that has lower Tracking error is considered better as it has given returns equal to the index.

Hence the best practices will be as follows

• Start with index ETFs (e.g., Nifty 50 ETFs) for low-risk exposure.
• Diversify your portfolio across asset classes (equities, gold, debt).
• Monitor tracking errors and liquidity for efficient execution.

ETF Vs Mutual Fund Differences

ETFs and Mutual Funds are the most popular investment instruments in India. Here are some core ETF vs  Mutual Funds differences. 

Refer to the table below to understand the concept better. 

      > One major difference between ETFs and Mutual Funds is the way they are traded. ETFs are traded like stocks and mutual funds are traded once at the end of the day. 

      > The cost of Mutual Funds Is higher which can eat into returns over time. 

         ETFs usually have lower expenses and don't have redemption fees or sales load that mutual funds often charge.

      > Mutual funds help in the diversification of various assets like stocks bonds debt hybrid etc. 

          ETFs usually follow indexes such as Nifty 50  and Sensex and offer exposure to a wide range of companies across various sectors. 

      > Another difference between ETF and Mutual Funds is the taxes levied on the gains. If you have gained on the Mutual fund held for less than a year, you will have to pay higher taxes as compared to the gains on the ETF held for one year. 

Conclusion 

An ETF is a pool of funds that is actively traded throughout the day on the stock exchange. It has several significant benefits over Mutual funds. However, the decision to invest is solely on your financial requirements. To understand ETF better you can download our detailed ETF guide. 

ETFs are great for cost-conscious investors who want the flexibility to buy or sell at any time and benefit from tax efficiency. Their low costs make them a good choice for long-term investors who prefer a simple, index-based approach.

Mutual funds, like target-date funds, offer professional management and work well for retirement savings with a structured approach. They may cost more but include features like automatic rebalancing.