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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

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.

Benefits of Investing in Mutual Funds

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.

Who Should Consider Mutual Funds?

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.

Exchange-traded Funds (ETFs)

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.

Benefits of Investing in ETFs

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.

Who Are ETF Investments Suitable For?

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.

What Is The Difference Between ETFs and Mutual Funds?

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

 

ETFs

Mutual Funds

Fund Management

Actively managed. Assets are picked to maximise returns.

Passively managed. Assets are picked to match the returns of a specific index.

Fund Valuation

The value varies during the day. You can buy or sell at the prevailing market price during this time.

The NAV at the end of the day is the valuation of the mutual fund. 

Liquidity 

Higher liquidity due to easy daily trading.

Liquidity is affected by minimum lock-in periods and penalties for early exit.

SIP Option

Not available.

Available, starting at ₹100 per month.

Expense Ratio

Typically less than 1%

Typically in the range of 2.5%-3.0%

Investment Mechanism

New ETFs are traded on the stock market. To start trading, you need to open a DEMAT account 

New Fund Offerings or NFOs are newly issued mutual funds which you need to buy from fund houses. You don’t necessarily require a DEMAT account.

In conclusion, keep in mind that ETFs and mutual funds are both market-linked instruments carrying significant risk. The investment decision should be based on your investment goals and other factors as mentioned above. 

 

With mutual funds, compare past returns and future projections before deciding. You can do so on Bajaj Markets and choose from hundreds of highly rated mutual funds.

FAQs on ETFs and Mutual Funds

What is an ETF's minimum investment requirement?

There is no minimum investment amount specified for ETFs.

Are ETFs and index funds the same?

No, index funds are passively-managed mutual funds. It is similar to ETFs in the sense that it seeks to match the performance of a specific index.

How to invest in ETFs in India?

To invest in ETFs, you will require a Demat account where you can compare the ETF offerings and make a trade.

Is SIP possible in ETFs?

No, you can’t invest in ETFs via SIPs.

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