Difference Between Exchange Traded Funds and Mutual Funds Explained

difference between mutual funds and etf

ETFs and mutual funds are popular investment products. However, their structure and trading mechanisms differ vastly.

Such trades happen on the stock exchange, like individual stocks. At the end of the trading day, investors buy and sell mutual funds based on their NAV.

Understanding the difference between ETFs and mutual funds is essential in investing. Both provide advantages that suit the investor's goal, risk tolerance, and preferences.

Keep reading to learn more about how an ETF differs from mutual funds, its risk, and other important factors.

Table of Contents

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What are Exchange Traded Funds?

Exchange-traded funds, or ETFs, are mostly passively managed funds traded on the stock exchange. They comprise stocks and bonds that carry the underlying index's exact value. Individuals can buy, sell, and transfer them quickly.

ETFs are traded throughout the day, so the value of the assets fluctuates, so you need to buy them at their current market price. As mentioned, ETFs solely replicate an index, thus requiring no fund manager to monitor them actively.

ETFs are used for purposes like arbitrage, hedging, and equitising cash. The shareholders receive dividends paid and interest earned as a part of the profit.

What are Mutual Funds?

Mutual funds accumulate funds from various investors and trade in diversified assets. Professional fund managers actively manage these investment funds. These investors put their money in bonds, stocks, debt, or money market instruments.

You purchase or sell a mutual fund at its Net Asset Value or NAV. You can obtain it by dividing the total assets by the number of investors.

The investors hold a share of a mutual fund and experience the same profit or loss as other investors.

Exchange Traded Funds vs Mutual Funds: Which is Better?

Here's a tabular representation of the difference between ETF and mutual funds in India.

Differences Exchange-traded Funds Mutual Funds
Transaction ETF units can be bought or sold at their current market price throughout trading. They can be bought or sold at their net asset value (NAV), fixed for a trading day.
Expense Ratio Lower expense ratio. Active mutual funds have a higher expense ratio.
Lock-in Period No lock-in period. Close-ended and ELSS funds have a lock-in period.
Liquidity ETFs have higher liquidity. Mutual funds have comparatively lower liquidity.
Brokerage Investors pay brokerage for ETF investments. Brokerage is not applicable.
Demat Account Mandatory Not required.
Minimum Investment ETFs allow investors to start investments with small amounts. According to SEBI regulations, the minimum investment amount for a mutual fund in India is typically ₹100 for a lump-sum investment and ₹500 for a Systematic Investment Plan (SIP).
Taxation The taxation of exchange-traded funds (ETFs) in India depends on the type of ETF and the investment period. Mutual funds are taxed based on the type of fund, the investment duration, and whether the fund pays dividends.
Diversification ETFs diversify risk by creating a portfolio spanning multiple asset classes, sectors, industries, and security instruments.  Mutual funds diversify risk by creating a portfolio spanning multiple asset classes, sectors, industries, and security instruments.

If you ever wonder which is better among ETF vs mutual funds, you may consider the following factors -

  • Your risk appetite
  • Liquidity of your investments
  • Your investment horizon
  • Your financial goals
  • Expense ratio

Types of ETFs

There are various types of exchange-traded funds (ETFs), such as:

Types Description
Equity ETFs They are index-based and invest in the same proportion of securities as the underlying index. They are cost-effective and transparent.
Debt ETFs ETFs invest in bonds and other debt products. They are considered safe investments that provide steady returns.
Commodity ETFs These are invested in physical commodities such as precious metals, farm products, and natural resources.
Index ETFs These are reproductions of an actual index, like the S&P 500 Index, offering investors access to a broad market segment or sector with low fees.
Currency ETFs These invest in one currency or a basket of currencies, which enables investors to gain exposure to foreign exchange markets.
Inverse ETFs These ETFs use derivatives to short a stock, earning gains when the stock declines in value.
Actively Managed ETFs These are managed by an investment team or manager who decides how to allocate portfolio assets.
Leveraged ETFs These financial derivatives allow investors to leverage their investments and increase their gains.

Types of Mutual Funds

Mutual funds can be categorized in several ways, including by asset class, risk, and investment strategy:

Types Description
Money Market Funds Funds make investments in short-term, low-return securities such as commercial paper, Treasury, and certificates of deposits with stable returns, which are perfect in case of liquid/safety search investment.
Equity Funds These are also known as growth funds, which are invested primarily in company stocks. They are a good choice for investors looking for long-term portfolio growth.
Hybrid Funds These funds invest in a mix of equity and debt instruments. Equity-oriented hybrid funds are good for investors looking for stable growth, while debt-oriented are good for conservative investors.
Debt Funds A debt fund invests in fixed-income securities, such as government bonds, corporate bonds, treasury bills, and commercial paper. Debt funds are also known as income funds or bond funds.

Benefits of ETFs and Mutual Funds

ETF is an attractive investment option for most investors. However, mutual Funds also offer many advantages that explain their popularity in investors' minds. Here are some significant benefits of investing in both:

Basis Benefits of ETFs Benefits of Mutual Funds
Trading Flexibility You can buy or sell ETFs throughout the trading day. This allows flexibility and the ability to react to market movements, like individual stocks. This intraday trading feature makes ETFs very liquid. An experienced portfolio manager manages the Mutual Fund on behalf of investors and invests money. The role benefits people with less time and expertise on the matter.
Management Style ETFs have lower management fees than Mutual Funds. Most ETFs are passively managed, tracking an index. This cost efficiency can add to the high long-term returns for investors. Like ETFs, Mutual Funds offer immediate diversification by pooling money from multiple investors. It invests in many assets that help to spread out risk. This decreases volatility within a portfolio.
Diversification  Depending on the fund's focus, you will be exposed to many securities, either stocks or bonds. This diversification spreads risk. It reduces the impact of poor performance on individual assets. Mutual funds often let the investor reinvest dividends and capital gains automatically. This helps the investment grow over time without intervention and extra costs.
Minimum Investment Most ETFs are transparent as they update the holdings regularly. Thus, the investors know where their money is invested and can control what happens in the portfolio. Most mutual funds have low minimum requirements for investment. It provides a suitable means by which new or small investors can build a diversified portfolio without a large upfront outlay.
Tax Efficiency ETFs tend to be more tax-efficient than Mutual Funds. Their structure allows them to avoid capital gains tax when the shares within the fund are sold or bought. Mutual Funds provide an opportunity to set up automatic investment plans. An investor can contribute a fixed amount of money to their fund. This strategy helps reduce market fluctuations.
Investment Approach ETFs are open to investors of all experience levels. They are accessible with low minimum investments in some ETFs. It allows for broad participation in a wide range of asset classes. Mutual funds are always designed with long-term in mind. That's why some people prefer mutual funds. They are suitable for a passive, long-term investment approach. This is good with compounding growth.

 

Once you have your priorities set, you can choose your investment. Mutual funds generally require a longer investment horizon than exchange-traded funds. On the other hand, ETFs offer you higher returns, more flexibility, and tax benefits in the short run.

Now that you know about exchange-traded funds (ETF) versus mutual funds, you can utilize both to build a diversified portfolio.

Disclaimer: The information provided on this website is for general informational purposes only and should not be construed as financial, investment, or legal advice. While we strive to provide accurate and up-to-date content, we do not guarantee the completeness, reliability, or suitability of the information for your specific needs.

We do not promote or endorse any financial product or service mentioned in these articles. Readers are advised to conduct their own research, consult with financial experts, and make informed decisions based on their unique financial circumstances. Any reliance you place on the information provided here is strictly at your own risk.

FAQs about ETF vs Mutual Funds

Which is better, mutual funds or an ETF?

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ETFs are better for people seeking flexibility. They trade like stocks throughout the day and often have lower fees. They suit investors focused on passive, low-cost investing. Mutual funds are better for those preferring professional fund management. Mutual funds aim at outperforming the market.

Do ETFs grow faster than mutual funds?

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Yes, ETFs grow faster than mutual funds. They have lower expense ratios, greater liquidity, and the ability to trade throughout the day on an exchange. This allows them to react quickly to market changes. However, mutual funds are only priced at the end of the trading day.

Why is a mutual fund expensive when compared to an ETF?

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Mutual funds are generally more expensive than ETFs. Most mutual funds need a team of fund managers to research and select individual stocks to beat the market. This incurs higher fees than ETFs. ETFs passively track a market index and have lower management costs.

Are ETFs riskier than Mutual funds?

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Both exchange-traded funds (ETFs) and mutual funds have risks. However, ETFs are generally considered less risky than actively managed mutual funds.

What is the difference between ETFs and mutual funds?

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ETFs (Exchange-Traded Funds) trade on stock exchanges like individual stocks. It offers flexibility to buy and sell throughout the day. Mutual funds are bought and sold at the end of the trading day at the net asset value (NAV). ETFs have lower fees, while mutual funds may offer more active management options.

What are the advantages of mutual funds over ETFs?

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Mutual funds offer several advantages over ETFs. It includes support services, fractional shares, diversification, convenience, tax-free gains, and active management.

Does ETF have an exit load?

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No, Exchange Traded Funds (ETFs) do not have an exit load. You can buy or sell ETFs anytime during the trading day without a fee.

Are ETFs tax-efficient when compared to mutual funds?

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Yes, exchange-traded funds (ETFs) are generally more tax-efficient than mutual funds. Holding an ETF in a taxable account generates less tax liabilities. If you had a similar structured mutual fund in the same account, it would be more taxable.

Why should I choose an ETF over mutual funds?

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Choose ETFs because they offer investments with lower operating costs. They are also more flexible and have high liquidity. Mutual funds operate with less liquidity and high maintenance fees.

Which one among ETFs and mutual funds has a lock-in period?

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Only close-ended mutual funds and ELSS funds have a lock-in period.

Other Important Articles about Mutual Funds

What is Growth Mutual Fund?
CAGR vs Absolute Return
What is Interval Fund?
What is Mutual Fund?
ETF vs Index Funds
What is Lock in Period in Mutual Fund?
What is Systematic Investment Plan(SIP)?
Types of Mutual Funds in India
Arbitrage Fund vs Liquid Funds
Flexi Cap vs Multi Cap Funds
How Mutual Funds are Taxed?
What are Arbitrage Funds?
Gold Mutual Fund vs Gold ETF
What are Debt Funds?
What is Equity Fund?
IDCW vs Growth
What is Hybrid Fund?
Types of Mutual Fund Returns in India
What is Statutory Liquidity Ratio?
What is Index Fund?
Open Ended Fund vs Closed Ended Fund
What are Multi Cap Mutual Funds?
SIP vs Mutual Funds
What is Income Fund?
Sharpe Ratio vs Treynor Ratio
What is International Fund?
Direct vs Regular Mutual Funds
Index Funds vs Mutual Funds
IDCW vs SWP
What are Corporate Bond Funds?
Difference Between Smallcase and Mutual Funds
Value Funds vs Growth Funds
SIP vs PPF
Mutual Fund Charges or Fees
XIRR vs CAGR
What is Money Market Fund?
ETF vs Mutual Funds
What is XIRR in Mutual Fund?
Fixed Deposit vs Mutual Funds
What are Leveraged Funds?
Liquid Funds vs Debt Funds
Active Funds vs Passive Funds
What is Lumpsum in Mutual Fund?
What are Commodity Mutual Funds?
NPS vs Mutual Funds
Sharpe Ratio vs Sortino Ratio
Bonds vs Mutual Funds
ELSS vs SIP
Balanced Funds vs Equity Funds
Mutual Fund vs Life Insurance
What is Exchange Traded Fund?
Equity Funds vs Debt Funds
Growth Fund vs Dividend Fund
What are Sectoral Funds?
PPF vs Mutual Funds
SIP vs Lumpsum in Mutual Funds
ETF vs FOF
What is ELSS?
What is Capital Protection Fund?
Annualised Return vs Absolute Return
SIP vs RD
What is a Balanced Fund?
Mutual Funds vs Stocks
Mutual Funds vs Hedge Funds

Disclaimer

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  • This is an informative article provided on 'as is' basis for awareness purpose only and not intended as a professional advice. The content of the article is derived from various open sources across the Internet. Digit Life Insurance is not promoting or recommending any aspect in the article or its correctness. Please verify the information and your requirement before taking any decisions.
  • All the figures reflected in the article are for illustrative purposes. The premium for Coverage that one buys depends on various factors including customer requirements, eligibility, age, demography, insurance provider, product, coverage amount, term and other factors
  • Tax Benefits, if applicable depend on the Tax Regime opted by the individual and the applicable tax provision. Please consult your Tax consultant before making any decision.

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