What is the difference between ETF & Mutual Fund?
If you are someone who wants to invest in mutual funds but does not possess knowledge about how they work, that’s alright; you can still invest in them. To simplify their how they function, mutual funds collect money from investors sharing a common investment objective and invest this pool of funds in various asset classes like equity, debt, government securities, corporate bonds, etc. Because mutual funds invest in multiple sectors and asset classes, they offer great diversification to an investor’s portfolio and also do a decent job of balancing risk.
However, if you are someone who doesn’t want to take too much risk with their investments, but still seek capital appreciation through equity investments, you can consider investing in ETFs. Exchange Traded Funds, or ETFs are funds which mimic the underlying index, for example, NIFTY, SENSEX, gold, etc. These are passively managed funds and hence have less involvement of the fund manager.
Making a choice between mutual funds and ETFs can be tricky sometimes. But if you know the differences between these two, it might help you make an investment decision to suit your financial objective.
| Parameters | Mutual Funds | ETFs |
| Definition | Mutual funds are a financial instrument who collect money from investors sharing a common investment objective and invest this pool of money in various money market instruments. | ETF is an open ended scheme which replicates / tracks the particular index. Of the total assets, this fund must invest a minimum of 95 percent in securities of a particular index (which is being replicated or tracked). |
| Type of fund | Mutual funds are actively managed funds which involve active participation of the fund manager who buys and sells fund units on behalf of its unitholders. | Exchange traded funds are passively managed funds which mimic the underlying index and involve very little participation from the fund manager. |
| Buy/Sell | Mutual fund investors are allotted units which they can redeem or withdraw as per their convenience | ETFs are traded at the stock exchange just like any other stock |
| Investment objective | The investment objective of mutual funds is to seek long term capital appreciation and outperform the index benchmark | The investment objective of an ETF fund is to imitate and outperform the underlying index with minimal errors |
| Expense Ratio | Since mutual funds are actively managed, they have a comparatively high expense ratio | As ETF funds are passively managed and do not have active participation of the fund manager, the expense ratio of owning an ETF is comparatively lower |
| Exit load | Generally mutual funds do not have any exit load. | ETF funds have exit load |
We hope that the above differences between mutual funds and ETFs are sufficient for an investor to identify which fund they want to invest in. However, both these funds are equity oriented and carry a moderately high risk. So investors should be prepared to bear losses as equity oriented investments are subject to market risk, and returns are never guaranteed. That doesn’t necessarily infer that an investor will compulsorily bear losses.
It is necessary to remember that investment is a long journey. You cannot expect the tables to turn overnight. If you wish to build a commendable corpus, then you need to treat your investment like a test cricket match, rather than expecting results of a T-20 cricket match. Patience is the key here, especially when it comes to mutual funds and ETFs. Historically, these funds have outperformed their benchmarks and given decent returns when stayed invested for the long run. So whether you invest in mutual funds or ETFs, having a long term investment horizon might help you achieve your ultimate financial goal.
