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    Mutual Fund vs. ETF: What Should You Select?

    Oct 11, 2022
    5 min
    4 Rating

    Confused between mutual funds and ETFs? Read this post to understand the major differences between the two and what you should select.

    Content

    Mutual funds have become the go-to investment option in India. With so many fund categories, there are schemes for every investor, risk appetite, and financial objectives. But like mutual funds, Exchange Traded Funds (ETFs) are growing in popularity too.

    If you’re building an investment portfolio, what should you choose between mutual funds and ETFs? Take a look at what they mean and know the major difference between mutual fund VS ETF -

    What are Mutual Funds?

    A mutual fund is a professionally-managed pooled investment vehicle. A mutual fund scheme pools investment through the sale of mutual fund units to investors and invests in securities based on its category and objectives. You can find mutual fund schemes that invest in stocks, government and corporate bonds, money market instruments, gold, real estate, and more.
    Asset Management Companies (AMCs) offer and manage mutual fund schemes. Every scheme has a fund manager responsible for investing and managing the pooled investment. Investors can make a lump sum investment or start an SIP (Systematic Investment Plan) in any mutual fund scheme.

    What are ETFs?

    ETFs or Exchange Traded Funds are passive investment vehicles that track indexes, bonds, commodities, or a basket of assets similar to index mutual funds. For instance, you can find ETFs with BSE Sensex or NSE Nifty as their underlying index. By purchasing units of these ETFs, you’re purchasing units of a portfolio tracking the returns and yields of the underlying index.

    Unlike mutual funds, ETFs are traded on stock exchanges. Like stocks, ETF prices change throughout the market hours depending on the demand and supply. While investors generally make lump sum investments in ETFs, some stock brokers offer ETF SIP facilities.

    Also Check - What are Index Funds?

    What is the Difference Between ETF and a Mutual Fund?

    Parameter

    Mutual Funds

    ETFs

     

    Management

    Most are actively managed, but there are fund categories like index mutual funds with a passive management style.

    Passively managed funds that only track indexes, bonds, commodities, etc.

     

    Buying/Selling

    Can be purchased and redeemed at closing NAV (Net Asset Value) from the fund house.

    Actively traded on stock exchanges, and prices change throughout market hours due to demand and supply.

     

    Management Fees

    Management fee or expense ratio can be relatively higher in actively managed mutual funds.

    Usually, ETFs carry lower management and other associated expenses as the fund is managed passively.

     

    Minimum Investment

    Mutual funds generally have a minimum investment amount of Rs. 500 or Rs. 1,000.

    No minimum investment amount and you can also purchase one unit of any ETF.

     

    Lock-in Period

    Some mutual funds like ELSS (Equity Linked Savings Scheme) have a lock-in of 3 years.

    No lock-in period, and you’re free to buy and sell ETFs as required.

     

    Returns

    Mutual funds, like equity funds, aim to generate returns higher than the underlying benchmark/index.

    ETFs merely mimic the returns of the underlying index.

     

    Investment Risk

    The risk can range from low to very high depending on the fund category and scheme you’ve selected.

    Generally considered low-risk due to their passive nature and diversification across equity and other securities. However, they are more prone to market risks as they are traded openly on the stock exchange.

     

    Managerial Risk

    Higher managerial risk in actively managed mutual funds as fund managers actively buy/sell securities.

    Lesser managerial risk as the ETF only mimics an index and does not require the active participation of a fund manager.

     

    Taxation

    The tax rate depends on the fund category (equity or debt), and the holding period.

    Equity-oriented ETFs are taxed similarly to equity funds, while debt, gold, and international ETFs are taxed as debt funds.

     

    Which One to Choose, ETF or Mutual Funds?

    Here,
    Once you understand the difference between ETF and mutual fund, the selection shouldn’t be difficult. Here are the factors you should consider before investing-

    • Risk Appetite

      While ETFs generally have lower potential risks, mutual funds vary in terms of risk depending on their asset allocation and investment strategy.

    • Investment Expertise

      With mutual funds, you get access to professional management. You can relatively stay invested for a longer duration without making investment decisions as there’s a fund manager responsible for building and managing the portfolio. With ETFs, you make investment decisions, like entry and exit, yourself.

    • Returns Expectation

      Actively managed mutual funds constantly strive to beat the benchmark and potentially aim to generate higher returns. However, ETFs only mimic the index and aim to deliver similar returns.

    • Tax Saving Strategy

      If you’re looking for tax-saving investments, mutual funds like ELSS can be a good choice as they’re eligible for deductions of up to Rs. 1.5 lakhs in a financial year under Section 80C of the IT Act.

    Investing in Mutual Funds and ETFs

    Both mutual funds and ETFs have their advantages. You can select one based on the above points or even consider investing in both to build a well-diversified portfolio.

    If you’re unable to decide between ETF or a mutual fund, you can also consult a professional investment advisor who can recommend the right investment based on your risk appetite, time horizon, and investment objectives.

    Mutual Fund investments are subject to market risks, read all scheme related documents carefully.