Difference between ETFs and mutual funds. All you need to know about
ETFs are very similar to Mutual funds, but they are not mutual funds. It’s just a matter of grasping the difference between ETF and mutual funds.
EduFund believes that understanding where each instrument makes the most sense, and the investor doesn’t blindly follow the crowd and the trend.
At the very outset, let’s know why they are so similar before diving into their differences.
What are the similarities between Exchange Traded Funds(ETF) and Mutual Fund(MF)?
Both Exchange Traded Funds and Mutual Funds represent a basket of professionally-managed securities: stocks, bonds, currencies, commodities, real estate, etc.
The placement of these securities is done either thematically or otherwise, depending upon the type of mutual fund or the ETF you chose.
Both offer various investment options and professional portfolio managers oversee the investments. Thus, saving your time and energy for research.
ETFs and Mutual funds are highly diversified because of the basket of securities. Thus, they are less risky than investing in individual securities like stocks, bonds, commodities, currencies, etc.
How does this help reduce risk?
Imagine if you are holding a stock that is performing poorly, and thus your return will also be poor; perhaps you may lose money too. However, suppose you have an ETF or a mutual fund. In that case, this poor performance of that stock may be compensated for by the good or average performance of other stores and assets, which together will give you a better return than holding a single asset otherwise.
What is the difference between ETF and mutual funds?
- ETF trading happens on the stock exchange, just like a simple stock on the (NSE) or (BSE) in Indian markets, or it will be listed on the NYSE or the Nasdaq when trading in the USA.
- Mutual Funds are not listed on the stock markets; they must be purchased manually from the fund through your financial advisor or online brokers.
- Investing in ETFs is very simple, i.e., they can be sold or purchased at any point in time in the day, just like a stock. However, this happens only once during the day – after the market has closed for mutual funds.
- The mutual fund company does this buying or selling mutual funds based on the investor’s instructions. This delay can be very costly if the market fluctuations are very dynamic. Straightforward and anytime trading of ETFs sounds cool, but not all ETFs are tradable, leading to illiquidity concerns.
- ETF purchases are made at the prevailing market price – typically near the NAV but not precisely the same.
- Generally, an investor purchases the mutual fund at the price of its NAV. Hence, most mutual funds allow automated transactions but ETFs do not due to price volatility.
- ETFs have a lower expense ratio as compared the mutual funds.
The expense ratio is the fee you pay the manager for managing your securities.
Reason is quite simple, ie: the trading of mutual funds, leaves a long paper trail, and thus the exchange of hands for this paperwork is more.
The paperwork translates to higher costs to the fund manager, and eventually to the investor.
On the contrary, ETFs are traded directly by the investor and thus naturally explain the lower charges.
Based on management, most of the ETFs are passively managed, whereas there are quite a few actively managed mutual funds, but there exist some mutual funds which are passively managed.
What is better?
Well, neither of the two is perfect! You can achieve diversity using any two options based on your goals.
Naturally, a portfolio balanced by combining both offers greater variety and lower risk. Notably, there is no reason this must be a tight rope walk situation.
Both, Mutual funds and ETFs can live together in a portfolio perfectly happily.