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ETFs vs Mutual Funds – Which one to choose?

Updated on: Jan 13th, 2022


5 min read

Securing your financial future is one of the most critical tasks that you need to perform. There are various options available for you to ensure that your money generates adequate returns as per your financial goals. Out of the many investment options available to investors in India, Mutual Funds and ETFs are amongst the most popular ones.

They both look quite similar at first glance, but when analyzed carefully, there are differences between both of them. Let’s get to know the difference between these two investment options and understand which one of these you should choose.

What are Mutual Funds?

Mutual funds can be described as professionally managed investment schemes that collect money from various investors and then invest it in diversified holdings. Mutual funds invest in a wide range of securities such as stocks, bonds, debt instruments and much more. Each scheme has a defined NAV (Net Asset Value) which is derived after dividing the total investment of a mutual fund by the number of investors.

What are ETFs?

ETFs or Exchange Traded funds are passively managed funds that merely replicate an index. These funds usually hold all the stocks in the same weight as they are held by the underlying index. ETF is not actively managed by a fund manager. It just tracks the performance of the index. ETFs are actively traded on a stock exchange and can be freely purchased and sold throughout the trading session.

Mutual Funds vs. ETFs

The decision between a mutual fund and an ETF is one of the major conundrums for an investor while taking an investment decision. Though both these products look quite similar, there are differences between them. Following are the significant differences between Mutual Funds and ETFs.

  • Flexibility: – ETFs are freely traded in the market and can be bought and sold as per the investor’s convenience. Their market price is available in real-time just like ordinary equity shares. Mutual funds units can be bought or sold only by placing a request with the fund house. NAV indicates price of one unit of a mutual fund.
  • Fees and Expenses: – As ETFs merely replicate the performance of an index, they do not need active management. As a result, the fees and expenses associated with ETF investments are low. While in the case of Mutual Funds, the fund manager actively takes investment decisions on behalf of the investors. As a result, the fund management expenses are higher.
  • Commissions: – As ETFs are traded like any other share on the exchange, investors need to pay commissions on sale and purchase of units as per the prevailing rules. While in case of mutual funds, there is no need to pay any commission for the sale and purchase.
  • Management: – Mutual funds are more likely to be managed actively by an experienced fund manager who takes all the investment decisions on behalf of the investors. While in the case of ETFs, the funds merely track the market index. There are some actively managed ETFs also, but they have a higher expense ratio.
  • Lock-in Period: – ETFs do not have a minimum holding period, and the investors are free to sell the investment as and when they like. Mutual funds like ELSS (Equity Linked Savings Scheme) come with a lock-in period of 3 years. During this timeframe, it is not possible to liquidate the investment. This can range from 9 days to 3 years, depending on the mutual fund scheme chosen.

How to decide between Mutual Funds and ETF

Both of the investment options mentioned above offer you an excellent way to build a diversified investment portfolio. As to which option should be chosen, there are many factors that need to be considered, such as: –

When you have answered these questions, you will be able to narrow down as to which of the above two options you must choose. ETFs offer you more flexibility and higher returns in the short-run while mutual funds require you to stay invested for a comparatively extended period but help create a corpus for the future. The decision has to be entirely yours but must be taken after careful consideration.

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Quick Summary

Investing in mutual funds and ETFs are popular options in India. Mutual funds are managed investments with diversified holdings, while ETFs replicate an index and are traded on exchanges. Key differences include flexibility, fees, management, commissions, and lock-in periods. To choose between the two, consider factors like ease of liquidation, risk appetite, investment horizon, tax-saving strategy, and financial goals.

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