How exchange-traded funds are different from mutual funds?

So, why do we need to know the difference between exchange-traded funds and mutual funds in the very first place? ETFs are very similar to Mutual Funds, but they are not mutual funds. It’s just a matter of grasping the differences between the two.  

We at EduFund believe that understanding where each of the instruments makes the most sense, and the investor just 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. Exchange-Traded Funds and Mutual Funds represent a basket of professionally managed securities, such as stocks, bonds, currencies, commodities, real estate, etc.  

These securities can either be thematic or also depend upon the type of mutual fund or the ETF you chose. Both offer various investment options and are managed by professional portfolio managers.  

Thus, saving our time and energy in research. 

The 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 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 overdone by the good or average performance of other stocks and assets, which will give you a better return than holding a single asset otherwise. 

The most important difference between the ETFs and Mutual funds is that an ETF is tradeable on the stock exchange, i.e., its trading is just like a simple stock on the National Stock Exchange (NSE) or the Bombay Stock Exchange (BSE) if it’s traded in Indian markets or it will be listed on the New York Stock Exchange or the Nasdaq if it’s to be tradeable in the United States of America.  

On the other hand, Mutual Funds’ listings are not done on the stock markets; they must be purchased manually from the fund either through your financial advisor or through online brokers. 

The ETFs are easily transactable, i.e., they can be sold or purchased at any point in the day, just like a stock. However, for mutual funds, this happens only once during the day after the market has closed.  

This buying or selling of mutual funds is through the mutual fund company based upon the investor’s instructions – this delay can be very costly if the market fluctuations are very dynamic.  

While easy and anytime trading of ETFs sounds cool, not all ETFs are as tradable. This leads to illiquidity concerns. 

Generally, an investor purchases the mutual fund at the price of its NAV, but on the other hand, ETFs are bought at the prevailing market price, which is typically near the NAV but not the same.  

Hence, most mutual funds allow automated transactions but ETFs do not because of price volatility. 

Generally, 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.  

The reason is quite simple when a mutual fund is traded, it leaves a long paper trail, and thus the exchange of hands for this paperwork is more – translating to higher costs for the fund manager, which are imposed upon the investor.  

On the contrary, ETFs are traded directly by the investor and thus naturally explain the lower charges. 

Based on management, most ETFs are passively managed, whereas there are quite a few mutual funds that are actively managed, but some are passively managed. 

What is better? 

Well, neither of the two is perfect! You can achieve diversity using any of the 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 happily.

Consult an expert advisor to get the right plan for you