Mutual Fund vs. ETF

An Exchange-Traded Fund or ETF is a pool of money acquired from investors, which is invested into diverse assets. In this sense, ETFs are similar to mutual funds, which are also pooled securities used by investors to diversify. The similarities, however, end there. 

Fund managers actively manage mutual funds to maximise investor returns. However, ETFs are passively managed since they are meant to match the returns of a specific index. Further key differences between ETFs and mutual funds lie in cost structure, return models and liquidity. 

Mutual funds deploy the pool of money collected from investors based on their shared investment objectives. This could be stable income, capital protection, exponential returns, tax-saving and more. Based on your objective and risk appetite, you can choose to invest in equity, debt or hybrid funds. 

On the basis of your contribution to the fund, you get allotted units. The value of each unit is expressed as Net Asset Value or NAV, which is calculated as:

NAV = [Assets – (Liabilities + Expenses)] / Total outstanding shares

This NAV is calculated only at the end of the day. Your mutual fund investment value and units allotted depends on the NAV.

By choosing to invest in mutual funds, you stand to benefit in the following ways. 

• Professional management: A team of experts including the fund manager actively manage the fund. This enables quick response to market movements. Hence, it makes investing easier for investors who aren’t finance experts but want to leverage the financial markets.  

• Affordability: You can start investing in mutual funds via SIPs starting at ₹100 per month. These smaller monthly payouts are affordable for most investors. It also helps foster financial discipline in first-time investors.
  

Mutual funds are ideal investments for everyone. These are particularly suitable for small investors who don’t have large sums for investment, and seasoned investors looking to park a lump sum. These are also well-suited to investors who wish to grow their wealth, but lack the knowledge to do so.

ETFs are investment funds that employ passive fund management. It combines the ability to invest in diversified assets with the flexibility of trading in stock exchanges. If the ETF tracks a stock index such as the NIFTY 50 or BSE SENSEX, investors are entitled to dividends. 

They are typically reinvested in the scheme and the fund provider who owns the underlying assets forms a fund to track its performance. This is offered to investors in the form of shares in the ETF. The money pooled from investors is then allocated to these assets, namely stocks, bonds, commodities, or currencies.

Here are some benefits unique to ETFs that could help decide whether to invest in ETFs or mutual funds. 

• Transparency: The majority of ETFs report their holdings on a daily basis. Also, since returns are measured against prevailing indices, it is easier to discern their profitability. 

• Tax Efficiency: ETFs are slightly more tax-efficient than mutual funds. Lower rates on capital gains taxes are enjoyed, as such:

  1. Equity shares: 15% short-term capital gains, 10% long-term capital gains, after an initial exemption of ₹1 Lakh 

  2. Non-equity shares: Short-term capital gains are treated as regular income, while long-term capital gains are taxed at 20% after indexation.

ETFs are suitable for both first-time equity investors and traders. First-timers can benefit from the transparency and predictable returns, while seasoned traders can hedge their position for real-time gains.

The main factors differentiating ETFs from mutual funds are as follows: