ETFs (Exchange Traded Funds) & Mutual Funds are investment avenues that are managed by a Fund manager and allow Retail investors to invest in them. ETFs are listed on Stock Exchanges, and Mutual Funds are not. Usually, ETFs track an Index or sector whereas Mutual Funds offer a much more variety of Funds from which an investor can choose from. Both of these investment vehicles have their own merits and demerits. One should evaluate their risk profile and goals and choose one of them either. Find out which of these is the better option.
ETFs and Mutual Funds are both investment tools that collect money from the investors and invest it accordingly. There are some differences between ETFs and Mutual Funds, let’s look at them in detail.
Mutual Funds
Mutual Funds are funds that collect money from the investors and use that money to buy securities from the market. This is done on behalf of the investors and whatever Gain or loss is incurred in the process, the fund house passes it on to its investors. While doing so a Mutual Fund charges a nominal fee for its services in the form of an Expense Ratio which is charged by the customers of that Fund.
ETF (Exchange-Traded Fund)
ETFs are also similar to Mutual Funds to some extent but not completely. ETFs usually track an index or a particular sector where not much rebalancing or buying & selling is required. ETFs that track an Index pass on the same return as the Index at a minimum Expense Ratio. The expense ratio on ETFs is lower compared to Mutual Funds as ETFs are mostly passive funds where to overhead costs are less.
Which of them Better for Investors?
Both investment vehicles have their own pros and cons. An individual should identify their requirements and Risk profile before investing in either of them. This question could be answered in 2 different perspectives of investment.
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Active Investor- An active investor is a person who is actively tracking the markets and wants to invest in a concentrated sector or a group of stocks. For them, Mutual Funds could be a good option, as there are many types of funds available out there. There are sector-specific funds like Pharma, Auto, etc. These kinds of funds diversify their investments into various stocks of that specific sector making the risk minimum.
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Passive Investor- Passive Investors are investors who don’t track the markets regularly, or want to rebalance their portfolio too often. For passive investors, ETFs can be a good option because ETFs mostly track index or sectors and are low-cost compared to Mutual Funds. The risk is comparatively less than focused mutual funds as an Index ETF tracks the broader Index rather than a sector. The cost of an ETF is also low compared to Mutual Funds.
Some other Differences between a Mutual Fund & ETF
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Cost- The cost or the Expense ratio charged by ETFs is less than Mutual Funds. This is because ETFs simply track the underlying asset hence the overhead costs are low.
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Minimum Investment- The minimum investment in an ETF is the price of 1 ETF whereas some Mutual Funds have their minimum limit at 1000 to 5000 rupees which can be high for some investors.
Conclusion
Considering the above points one can easily find out which type of Fund suits their requirements. One should also assess their Risk profile before choosing the type of ETFs or Mutual Funds. To make an ideal portfolio one should ensure that there is proper diversification. There should be a mixture of Debt and Equity in every portfolio so that, one is protected by the market downside with their Debt allocation.
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I think it is better to stick to mutual funds instead of ETFs. Price deviation between ETFs and its real price can be huge at any time and this means that you will get poor price discovery.
What often gets overlooked is how behaviour impacts returns more than the product itself. An ETF held patiently can outperform an actively managed fund if investors avoid panic buying or selling. In the end, consistency and asset allocation usually do more heavy lifting than the choice of instrument.
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