Investment has become very complex today and the opportunities that investors have out there are many and could easily increase their capital. Selecting a proper investment instrument is crucial since your choice might affect your possible results and, thus, the entire vision of investment strategy.
This blog is to help you understand what they are, how they work and their benefits in support of your decision making.
What are mutual funds?
Mutual fund is an investing vehicle that pools investor capital and uses it to purchase a variety of securities, including stocks, bonds, and short-term loans. A percentage of the fund’s ownership and income is represented by the shares that investors purchase.
How mutual funds work
Mutual fund investment means you are putting your money with others collectively when making an investment. These pooled amounts are then used by the fund manager for an investment check, in order to achieve the investment aim of that specific fund. Last but not the least, investors purchase their share at the end of each trading day’s Net Asset Value (NAV) that determines the total value of all stock holding of the mutual fund divided by total number of shares existing.
Types of mutual funds
Mutual funds can be categorized into two main types. Here’s an analysis:
- Actively managed funds: These are also known as peer funds since they are managed by fund managers who seek to make trades in securities with an intention of outcompeting a specific benchmark index.
- Passively managed funds: These funds attempt to replicate the index by owning the same stocks in proportionate or in a similar manner and with an aim of getting similar performance.
Advantages of mutual funds
- Professional management: Investors get professional fund managers who make proper decisions regarding asset investments.
- Diversification: Mutual funds provide exposure to a wide range of securities, reducing individual asset risk.
- Ease of investment: Investing in mutual funds is fairly easy so everyone can participate in that market even without a lot of knowledge about it.
What Are ETFs?
Exchange Traded Funds or ETFs work like mutual funds whereby a large number of investors pool their cash to invest in a wide basket of instruments. But ETFs are traded on the stock market like stocks themselves.
How ETFs work
Exchange traded funds are used as investment instruments that track a basket of securities. It is when you acquire stocks in an ETF, you are actually investing in a small fraction of all the stocks in the particular fund. Unlike mutual funds, ETFs can be traded throughout the day and at market prices.
Types of ETFs
ETFs come in various forms, including:
- Stock ETFs: Track specific indices such as S&P 500 or sectors including technology or healthcare are other types of indices.
- Bond ETFs: These invest in fixed income securities and give exposure to different sorts of bonds.
- Thematic ETFs: These focus on particular themes or trends, for example on renewable energy or artificial intelligence.
Advantages of ETFs
- Lower Costs: The major type is usually cheaper than mutual funds mainly because they are passive in their approach to investing.
- Trading Flexibility: Compared to mutual fund shares, shareholders can purchase and sell ETFs from time to time at the going market rates, making the unit highly liquid.
- Tax Efficiency: As a rule, capital gains taxes on ETFs as a type of investment tools are less than on mutual funds because of their organizational structure.
Key differences between mutual funds and ETFs
| Aspect | Mutual Funds | ETFs |
| Management Style | Can be actively or passively managed. | Primarily passively managed, tracking specific indices. |
| Trading and Liquidity | Purchased at NAV at the end of the trading day. | Traded on exchanges throughout the day like stocks. |
| Fees and Costs | Typically have higher management fees and expense ratios. | Generally lower costs but may incur trading commissions. |
| Tax Efficiency | May distribute capital gains tax liabilities to investors. | More tax-efficient due to “in-kind” redemptions that limit capital gains distributions. |
| Investment Minimums | Often have higher minimum investment requirements. | Usually allow for smaller initial investments since they can be purchased per share. |
| Transparency and Holdings | Holdings are disclosed quarterly. | Holdings are updated daily, providing greater transparency. |
Similarities between Exchange Traded Funds(ETF) and Mutual Funds (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.
Which one is right for you?
Choosing between mutual funds and ETFs depends on several factors:
- Investment Goals: Think about whether you want profits over time or in the short-term.
- Risk Tolerance: Self evaluate your tolerance level to market risks.
- Time Horizon: Decide on the time horizon that will let you know when you would need to withdraw money from your investment.
- Management Style Preference: Decide if you prefer active management (mutual funds) or passive management (ETFs).
- Budget for Fees and Trading Costs: Consider how quickly you are willing to spend money on investment management.
Understanding mutual funds is essential for making informed investment choices that align with your financial goals.
Conclusion
Mutual funds offer unique benefits that cater to different investor needs. EduFund offers a curated selection of mutual funds designed to help parents and students achieve their education dreams. Invest now!
FAQs
What’s riskier – ETFs or Mutual Funds?
One thing that investors must understand is that the riskiness of a fund doesn’t depend on the structure of the investment, but rather primarily on the underlying holdings. So, there is no reason to believe that one of these two investment options could inherently be riskier than the other.
Why should one choose a mutual fund over an ETF?
It’s always great to have various options to choose from and that’s what mutual funds provide to an investor. Mutual funds give an advantage of variety that ETFs can’t.
Are there any disadvantages of ETFs?
Every coin has two sides. Although ETFs could be proved extremely fruitful in increasing your savings in the long run, they may also have a few drawbacks. Some of them include a higher trading fee, trading errors, potentially less diversification, etc.
What is the main difference between ETF and a mutual fund?
ETFs are very similar to Mutual funds, but they are not 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.
Are ETFs safer than mutual funds?
Any investment has some element of risk attached to it. The risk of investing in an ETF or mutual fund varies based on the choice of the investor, no two mutual funds carry the same risk, and this applies to ETFs as well.
Which is better, an ETF or a mutual fund?
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 tightrope walk situation.
What are the two key differences between ETFs 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.
Mutual funds are actively managed investment options, while ETFs are passively managed investment options.
Consult our expert advisor to get the right plan for you
About the author
Niraj Satnalika
Head Of Research,EduFund
Dr. Niraj is a finance professional with 12+ years of experience and is part of the founding team at EduFund. He’s worked with Goldman Sachs, CRISIL and Sakal Media in roles spanning investment management, research and leadership. With a PhD in Finance from IIT Bombay, he brings deep expertise in valuation, governance and education planning. When he’s not teaching or writing, you’ll find him cooking or going on long drives.
