In India, there are a lot of investment options available through which you can invest and grow your money. Each investment option has its own set of features, pros and cons.

 

One can invest in equity, debt, and gold directly, through mutual funds, or ETFs. But what’s the difference between mutual funds and ETFs?

So, let’s first understand mutual funds and ETFs individually,

 

What is an ETF?

– ETFs are Exchange Traded Funds that are traded on stock exchanges like any other stock.

– Exchanged Traded Funds are generally passively managed funds i.e. ETFs track a particular index and try to mirror the returns of the same index subject to tracking error            (Tracking error is the difference in the actual performance of ETF and the performance of the index it is tracking)

– ETFs also offer diversification like mutual funds as various stocks are listed on that index.

– ETFs share many of the benefits of mutual funds while also offering the flexibility of stocks; they function like index funds but are listed on stock exchanges, allowing for easy trading. For investors looking to combine the advantages of both, exploring mutual funds online can be a great way to build a diversified portfolio with the convenience of digital trading.

– There are charges associated with trading ETFs like the commission charged on trading ETFs as you trade through a Demat account and expense ratio (which is generally low)

– There are no specific tax benefits of ETFs; it is the tax basis which ETF categories you are investing in.

 

Who should invest in ETFs?

– If anyone wants to invest in indices such as Nifty 50, BSE Sensex, or any other index and want to earn returns similar to indices.

– Investors who have an understanding and knowledge of the equity, debt, and gold market and can analyze the best-suited ETF for themselves.

– Investors who want to enjoy the benefit of diversification and want to be able to buy and sell whenever they want at real-time prices.

– Investors who want liquidity.

 

What is a Mutual Fund?

– Mutual funds are professionally managed funds wherein investors can invest their money in equity, debt, money market instruments, and any other securities as per the investment objectives of the mutual fund scheme.

– Mutual funds can be actively managed funds i.e. fund managers actively make investment decisions in order to outperform the market, or passively managed.

– Mutual funds offer diversification as they invest in various instruments basis the scheme type.

– You can invest in different asset classes like equity, debt, and gold through Mutual Funds

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Who should invest in Mutual Funds?

– Don’t have much time to manage their investments, as mutual funds are managed by professional fund managers. However, in India, there are more than 2500+ mutual fund schemes available and if one doesn’t have expertise then they can check out WWW.CURACAPITAL.IN

– Want to invest every month, as mutual funds offer two ways of investment i.e. SIP and lump sum

– Want to start small, as one can start investing in mutual funds with as low an amount as ₹100.

 

Exchange-Traded Funds (ETFs)

ETFs can cost far less for an entry position, as little as the cost of one share plus fees or commissions. An ETF is created or redeemed in large lots by institutional investors and the shares trade between investors throughout the day like a stock. ETFs can be sold short.

 

These provisions are important to traders and speculators but of little interest to long-term investors. ETFs are priced continuously by the market, however, so there's the potential for trading to take place at a price other than the true NAV. This may introduce an opportunity for arbitrage.

 

ETFs offer tax advantages to investors. As passively managed portfolios, ETFs (and index funds) tend to realize fewer capital gains than actively managed mutual funds.

 

Mutual Funds vs. ETFs

 

Mutual Funds

• Can own a variety of securities.

• Shares are purchased and sold only with the fund provider.

• Orders only settle after the market closes.

• Minimum investment is usually a flat dollar amount.

• May be active or passively managed.

• May be less tax efficient because sales of securities within the fund can generate capital gains.

 

ETFs

• Can own a variety of securities.

• Shares can be traded between investors.

• Orders settle during market hours.

• Minimum investment is typically equal to the price of one share.

• Are usually passively managed.

• May be more tax-efficient.

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A Detailed Comparison: Mutual Funds vs. ETFs

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Mutual funds and ETFs both offer the opportunity to more easily gain exposure to a large number of securities. Both are managed by a fund manager who tries to achieve the stated investment goals of the fund. An S&P 500 mutual fund or ETF typically tries to match the makeup and returns of the S&P 500 index. Investors can buy shares in the fund to get exposure to all the securities that it holds. Fund managers charge a fee called an expense ratio in exchange for managing the fund.

 

One of the key differences between ETFs and mutual funds is in how they're traded. You buy and sell shares directly with the fund provider with mutual funds. Transactions also only occur after trading ends for the day and the fund's manager can calculate the value of a share in the fund.

 

ETFs trade more like stocks. You can buy and sell shares in an ETF on the open market with other investors. It's also possible to buy or redeem shares with the fund provider but this is less common. Shares trade throughout the day rather than after the market closes so ETFs are a better choice for active traders.

 

ETFs are often cheaper to invest in as well. Mutual funds typically have minimum investment requirements of hundreds or thousands of dollars. You can invest in an ETF if you have enough money to buy a single share. ETFs are usually passively managed. Some mutual funds have more active management so ETF expense ratios are usually lower

 

Mutual Fund vs. ETF Redemption Example

 

Suppose an investor redeems $50,000 from a traditional Standard & Poor's 500 Index (S&P 500) fund. The fund must sell $50,000 in stock to pay the investor. The fund captures the capital gain if appreciated stocks are sold to free up the cash for the investor. This is distributed to shareholders before the year's end.

 

Shareholders pay the taxes for the turnover within the fund as a result. The ETF doesn't sell any stock in the portfolio if an ETF shareholder wants to redeem $50,000. It instead offers shareholders "in-kind redemptions" that limit the possibility of paying capital gains tax.

 

Is It Better to Invest in the Market Through a Mutual Fund or ETF?

The main difference between a mutual fund and an ETF is that an ETF has intra-day liquidity. The ETF might therefore be the better choice if the ability to trade like a stock is an important consideration for you.

 

Are ETFs Riskier Than Mutual Funds?

ETFs and mutual funds that otherwise follow the same strategy or track the same index are constructed somewhat differently so there's no reason to believe that one is inherently riskier than the other. The risk of a fund depends largely on its underlying holdings, not the structure of the investment.

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Do Index ETF vs. Mutual Fund Fees Differ Given the Same Passive Strategy?

The difference in fees is marginal in many cases. Some of the biggest and most popular S&P 500 ETFs have an expense ratio of 0.03%. Vanguard's S&P 500 ETF (VOO) has an expense ratio of 0.03%.

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The Vanguard 500 Index Fund Admiral Shares (VFIAX) has an expense ratio of 0.04%Do ETFs Pay Dividends?

Yes, many ETFs will pay dividend distributions based on the dividend payments of the stocks that the fund holds.

 

Have Index Funds Become More Popular?

Index funds track the performance of a market index. They can be formed as either mutual funds or ETFs. These funds have become more popular because they're passively managed and usually come with lower fees. They have lower research and management costs and this can be passed on to the investor in the form of lower expense ratios.Total net assets in these two index fund categories grew from 25% of all investment funds to about 50% between 2013 and 2023, according to research by the UCLA Anderson School of Management.

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The Bottom Line

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Mutual funds and exchange-traded funds are two popular ways for investors to diversify their portfolios rather than betting on the success of individual companies. The main difference is that ETFs can be traded throughout the day just like an ordinary stock. Mutual funds can only be sold once a day after the market closes.

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