Rahul, a young content writer, is confused about where to invest his monthly salary. He is a new earner, and the various investment options available confuse him more. Based on what his colleagues and peers suggested, he narrowed it down to the final two investment options – Mutual Funds and Exchange Traded Funds (ETF).
Mutual Funds and ETFs, at first glance, are almost the same, but when you analyse them extensively, the contrast is visible. But before we get into the distinctions, let us first understand what mutual funds and exchange-traded funds (ETF) are:
Managed by a fund manager, mutual funds are a pool of investors’ money with the same objective and risk appetite, invested in a wide range of securities and assets, like equity, debts, and much more.
The value of the mutual fund is calculated based on the Net Asset Value (NAV) at the end of the day. The per-unit NAV of a fund is determined by dividing the market value of that fund by the total number of units.
Exchange Traded Funds (ETF)
Unlike mutual funds, ETFs are passively managed by fund managers. They invest the pooled money of the investors. It holds various primary assets like bonds, stocks, gold etc.
These funds are open for trading and mainly trade in the intraday share market. Hence the value of ETF keeps fluctuating throughout the day. Since its traded-on exchanges, like stocks of a company, investors need to have a Demat account in order to invest in ETFs.
Now that you have an idea of what Mutual funds and Exchange Traded funds are, let us dig deep and find out what separates them from each other:
1. Method of Management
Fund managers at the investment firm are solely responsible for managing the Mutual funds. They make all decisions about where to invest money. The managers have the entire right to alter the investments and maximise the return. Whereas, for ETFs, fund managers have full authority to pick and dump the stocks the way they like. Hence, it is known as Passive management.
2. Lock-in Period
The money invested in mutual funds (only in ELSS (Equity Linked Saving Scheme)) gets locked in for at least three years. On the contrary, the money invested in ETFs is free of any lock-in period. Hence pretty much both the investment avenues provide you with flexibility and convenience.
3. Expense Ratio
The management fees associated with mutual funds are higher than ETFs. Therefore, the fund manager who manages the mutual funds must be on point and quick to devise a decision and execute it. Therefore, the expense ratio for mutual funds is high. However, for ETFs, the main objective is matching the market index and no comprehensive decision-making skill is required, which makes the expense ratio for ETFs comparatively lower.
Some complications may arise when you intend to change your portfolio management firm. For ETFs, there is no hassle. As they are known as portable investments, you can easily move them to a different firm. However, for mutual funds, the transfer is complex. Untimely closure of the funds can result in loss, and you cannot move from one firm to another without closing the fund positions. Hence, it may generate a loss scenario for investors.
Either of the investment options has tremendous potential to maximise your investments. Before choosing one out of the two options, you need to decide whether you want faster returns or returns for a long-term goal. An ETF would help you gain finances hurriedly for the short term, whereas mutual funds will aid your building corpus of money when invested over an extended period of time.