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Let us understand the concept of a mutual fund and an exchange-traded fund before diving into the differences between the two:
Mutual Funds
A mutual fund is an investment vehicle that pools money from investors and invests the accumulated corpus in a wide range of capital market securities. Mutual fund schemes may be actively managed by a dedicated fund manager or passively managed. A passive fund seeks to track the performance of a specific index or benchmark and invests on the same.
Exchange-Traded Funds (ETFs)
ETFs are a category of passive funds that can be traded on a stock exchange. Their investment portfolio mirrors an index (equity market index, bond index, commodity index, etc.). ETFs issue fresh units through a New Fund Offer (NFO), post which the subsequent sale and purchase of units take place on a stock market exchange. Since their NAVs reflect the index value, they generate returns in line with the benchmark or index.
Mutual Funds v/s Exchange-Traded Funds (ETFs)
| Basis | Mutual Funds | Exchange-Traded Funds (ETFs) |
| Type of Fund | Active Fund | Passive Fund |
| Trading Price | Is the NAV of the same day, previous day or next day based on the type of scheme, cut-off time and the order time. | Fluctuates throughout the day on a real-time basis |
| Flexibility | Lower since purchase and redemption can be executed at a fixed price which remains the same throughout the day | Higher since purchase and sale can take place at any time during the trading hours |
| Liquidity | Comparatively lower | Higher since ETFs are more marketable |
| Expense Ratio | Higher since actively managed | Lower since no investment strategy involved |
| Purpose | Creation of wealth, income-generating source, tax-saving, etc. | Arbitrage, hedging, speculation trading, earning on capital gains, etc. |
Advantages of Exchange-Traded Funds (ETFs)
An Exchange-Traded Fund would be a suitable investment for a trader who wishes to speculate on the price movements of an index. An ETF provides investors with direct control over their trades and lets the investors short sell and buy via margin-trading.However, it should be noted that investors must decide between investing in a mutual fund or an exchange-traded fund keeping in mind their investment objectives, liquidity needs, risk appetite, tax planning and investment horizon.
DISCLAIMER
The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.
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