Business Finance

Mutual funds vs ETFs: which one should you choose?

Mutual funds vs ETFs: which one should you choose?
Written by John

All of us have heard that investing is the way to secure your future and the right time to invest is now. And when we dive into the topic of investing, the most common term that pops up is Mutual Fund. You can read more about mutual funds meaning and the best investment options available! As you further keep on researching, the next emerging term is ETF. Everyone on the internet is saying ETFs and Mutual funds are the next two big things.

So before you invest your money blindly, it’s best to understand mutual funds meaning along with what exactly do you mean by ETFs, furthermore their pros and cons.

So let’s start with the mutual funds meaning

The meaning of mutual funds can be understood as investment schemes that are professionally managed and collect money from different investors and then invest it in a variety of holdings. The investment from the mutual funds is done in a wide range of securities, including debt instruments, stocks, shares, and more. Skilled fund managers effectively administer mutual funds to produce money for their investors. In return, the mutual fund houses charge investors with a fund management fee, in the form of an expense ratio.

Perks of Investing in Mutual Funds:

  • Diversification: There are different securities held by the mutual funds of companies belonging to various distinct industries, they are often less volatile than direct equity investments.
  • The expertise of Investment: There is a huge requirement of knowledge and experience which takes a lot of time to study the stock market sector for investment purposes. Therefore the funds are run by expert managers and they hence have the benefit of having professionals for the fund management and competitive edge.

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Now that we have read about Mutual funds meaning, so let’s see what ETFs are:

ETFs better known as Exchange Traded Funds are actively managed funds replicating merely an index. The ET funds generally hold all of the stocks with the same value as the elementary index holds them. An ETF isn’t handled professionally; anyone can have their own ETF. It just keeps track of index results. The stock exchange is where the ETFs are traded actively and can be openly purchased and sold during the entire trading session. ETFs don’t necessarily just track stock indices. They can also track bond indices (such as liquid ETFs) or commodities (such as gold ETFs).

Perks of Investing in ETFs:

  • Actively Traded: Unlike mutual funds, ETFs are actively traded on a stock exchange. A mutual fund may be listed on an exchange, but is typically not actively traded. Hence an ETF price can differ from the underlying value of the ETF (called NAV). It can trade at a premium or discount to the NAV of the ETF. A Demat account is required to trade and invest in an ETF
  • Passively Managed: An ETF is necessarily a passive instrument that frees them from the error problem of the fund manager, which in mutual funds is very much a possibility
  • High Liquidity: These are extremely liquid since ETFs are tradable securities. Yet not all ETFs on the stock exchange have the same liquidity. Typically large ETFs would have more liquidity, with huge assets under control. Therefore, investing in big ETFs than their smaller counterparts is safer because they have greater liquidity

Mutual Funds vs. ETFs

  • Management: The professionals who operate and make the investment decisions on behalf of the investors are the fund managers who have built their expertise in this field over the years and are considered to be trustworthy. Whereas, in the case of ETFs, the market index is the only variable for them. There are still several good managed ETFs, but they also have a higher ratio of expenses.
  • Flexibility: As mentioned above there are no restrictions for trading ETFs on the market, and they can be sold and anyone can buy them at their own convenience. Their pricing in the market is on a real-time basis, just like any other equity share. The fund house has an application process for mutual fund units that may be purchased or sold. In the domain of mutual fund, NAV refers to the price of one unit.
  • Lock-in Period: The investors are free to sell the investment anytime and whenever they wish as there is no fixed holding period for ETFs. Some mutual funds such as ELSS (Equity Linked Savings Scheme) have a minimum lock-in period, ELSS comes with a 3-year lock-in. The liquidation of these funds is not possible during this period. The lock-in period depends on the scheme chosen for the mutual funds, which may be as short as 9 days to as long as 3 years.
  • Commissions: The investors are expected to pay commissions on the selling and purchasing of ETF units as per the prevailing rules even as ETFs are traded on the exchange like any other asset. While there is no need to pay any commission for the sale and buy in the case of mutual funds.
  • Fees and Expenses: There is no active management time and efforts required in the ETFs as they merely replicate the performance of a market index. Resulting in lower fees and expenses associated with ETF investments. While the fund managers are professional and experienced people in the domain of mutual funds, they are actively involved in the investment decisions for the investors. Resulting in a higher expense for fund management.

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John

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