ETFs vs. Mutual Funds: A Head-to-Head Comparison for Smart Investors
12 July, 2024
Synopsis
ETFs can be traded like stocks, offer higher liquidity, and have lower expense ratios than mutual funds, but come with brokerage charges for buying and selling.
Mutual funds provide active management and a more comprehensive range of investment options but have higher costs and can only be bought/sold based on the NAV at the end of the day.
The choice between ETFs and mutual funds depends on an individual’s investment style, objectives, and risk tolerance. ETFs suit passive investors, while mutual funds appeal to those seeking active management.
In the stock market, there are funds like drones, and there are funds like combat aircraft. The ‘drone funds’ act as per the programmed script, irrespective of the market condition. On the other hand, the ‘combat aircraft’ funds, handled by experienced fighter pilots, are like fighter jets - they act and react to situations on a real-time basis. Likewise, in the context of markets, the Exchange Traded Funds, or ETFs, are the ‘drone funds’, while the mutual funds are the ‘combat aircraft funds.’ While both offer the benefit of diversification and professional management, ETFs and mutual funds have some key differences.
What Is the Difference between ETF And Mutual Fund
Understanding the Mutual Funds and ETF difference can help investors decide which investment vehicle suits their needs and style.
Mutual Fund versus ETF
ETF | Mutual Funds | |
Trading | ETFs are listed and traded on stock exchanges just like stocks. Their prices fluctuate throughout the trading day depending on demand and supply dynamics. Investors can buy and sell ETFs anytime during market trading hours at prevailing market prices. | Mutual funds can only be bought and sold at the end of each trading day at a price called the Net Asset Value (NAV). The NAV is calculated based on the closing prices of the securities held by the scheme. Investors cannot buy and sell mutual funds intraday like stocks or ETFs. |
Liquidity | The exchange-traded nature of ETFs makes them more liquid than mutual funds. Investors can buy and sell any quantity of ETF units whenever the market opens. | Mutual funds can only be transacted at the close of the market at NAV prices. Moreover, the sale of mutual fund units depends on order matching and the availability of liquidity with the fund house. |
Costs | ETFs have lower expense ratios compared to actively managed mutual funds. The absence of stock picking, research and fund manager fees helps keep ETF costs low. However, brokerage charges apply on buying and selling ETFs through a demat account. | Mutual funds have embedded expenses in terms of management fees and other recurring costs that are deducted from the fund's NAV. |
Taxation | ETFs attract lower taxes if held for over a year, making them more tax-efficient. Long-term capital gains from equity ETFs held over 12 months attract a 10% tax, while those from debt ETFs are taxed at 20% post-indexation benefit. | In mutual funds, long-term gains from equity funds are tax-free up to ₹1 lakh per year, while debt funds attract 20% tax after indexation. |
Minimum Investment | The minimum investment to buy an ETF unit equals its trading price, which could be as low as ₹200-500 on the NSE or BSE. ETFs score over mutual funds for retail investors with limited capital. | Mutual funds lumpsum investments typically have a higher minimum investment of ₹5,000 or more. SIP investments in mutual funds however start from ₹100. |
Diversification | ETFs provide diversification by investing in a basket of securities from an index, like Nifty 50 or Sensex. They cover a broad market spectrum at low costs. | Actively managed mutual funds aim to outperform the market by stock selection. They offer diversification across market caps, sectors, themes and investment styles. |
Investment Styles | ETFs are passively managed and just replicate the index. | Mutual funds involve active stock and sector selection by fund managers trying to deliver alpha over benchmarks. |
Risk | ETFs carry lower risk. | Active mutual funds carry the fund manager's performance risk. |
ETFs score over mutual funds regarding costs, taxes and intraday liquidity. However, mutual funds offer active management and participation in a wider range of stocks and assets. For passive investors, ETFs are low-cost to gain diversified market exposure. However, active mutual fund management can be more rewarding for investors willing to take on the performance risk. The thumb rule is to first assess your investment style and investment objective, then choose one - ETF or mutual fund – or maybe both!
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