Exchange-Traded Funds (ETFs) and Mutual Funds are currently ruling the financial discussions. Both are considered the best investment channels and might seem similar but are different in various aspects. To help you understand how these two vary from each other, this post mentions all the significant differences. Let’s have a read and understand more.
What are Exchange-Traded Funds (ETFs)?
Exchange-Traded Fund (ETF) is a basket of securities that are traded on stock exchanges. It replicates an underlying index. Commodities, bonds, and stocks are the assets to hold under it, and they are traded mainly for some amount closer to the original net asset value of the item during the trading day.
Majority of the ETFs traded on the stock exchanges are Equity ETFs or stock ETFs. There are bond ETFs and commodity ETFs as well. Just like a stock, the price of the ETF might vary broadly throughout the day on public stock exchanges. As a result, they are transferable and can be sold or brought quickly, like the stock shares. The supply of ETF supply is regulated through the redemption, and the creation process.
One of the major benefits of ETF is its lower fee and higher daily liquidity. Many fund houses offer various types of ETFs to their investors.
Types of ETFs
There are three kinds of ETFs.
Debt ETF: These ETFs allow investors to get an exposure to the fixed-income securities. They combine the benefits of debt investments with redemption flexibility and diversification of mutual funds. Debt ETFs trade mainly on the cash market of the National Stock Exchange and can be bought or sold consistently at the live market value. It is a passive investment instrument based on the indices. It invests debt securities in the same proportion as the underlying index.
Gold ETF: These are the funds that invest primarily in gold and can be bought or sold on exchanges. Gold ETFs are open-ended fund schemes that track the price of pure gold. Gold ETF is a better investment option than physical gold, as it does not have the problems associated with physical gold.
Equity ETF: Equity ETFs offer the benefits of direct stock investment and diversification of a mutual fund. Equity ETFs can be bought or sold during market hours at the current value. Equity ETFs invest in securities in the same proportion as the underlying index. Because of the index mirroring property, there is a full transparency over the holdings of an ETF. Moreover, as there is no involvement of the fund manager, equity ETFs have a lower expense ratio.
What are Mutual Funds?
Mutual funds are professionally managed investment funds where money is pooled from several investors and are invested in securities as per the investment aim of the fund. There are types of mutual funds and it can invest in money market instruments, bonds, stocks, and a combination of them all. In this article, the word mutual fund means actively managed funds.
Differences between ETF and Mutual Funds
Mutual funds and ETFs are baskets of investment securities. It helps to reduce the portfolio risk through diversification. However, the major difference between mutual funds and ETFs is the involvement of the fund manager. The objective of a mutual fund is to generate more returns than the benchmark index while ETFs aim to replicate the returns.
|Mutual Funds||Exchange-Traded Funds (ETF)|
|The unit price of the mutual fund i.e. NAV are calculated daily.||The value of an ETF varies during the day.|
|The expense ratio will depend on the type of fund and size of the fund.||Have a lower expense ratio|
|Most of them have a specified minimum expense||They do not get any fixed minimum expense|
|Can only be purchased directly from the funds at the fixed NAV price during the trading day||Can be bought and sold anytime on the stock exchange at the current market price|
|Zero transaction cost while buying or selling||An added cost is involved while trading ETFs, known as the ‘bid-ask spread.’|
|These are index-tracking but managed actively by the professionals. Investments are selected in such a manner that they beat the index while achieving higher performance.||ETF tracks an index, i.e., it tries to match index returns by replicating the index constituents.|
If you were also planning to invest in financial assets but were unsure about the right one to choose from, this article must have helped you conclude. After understanding both of them and learning about their differences, you can easily choose the best investment option that fits your needs.