- A mutual fund is an investment vehicle, which basically comprises a pool of investments from retail investors.
- ETFs are generally passively managed funds, which lead to very low management fee.
- Risk appetite plays a major role in selecting the type of investment fund.
When you are looking to invest in the financial markets, there are plenty of options available. Most investors, who have a knack of fundamental or technical analysis, prefer to directly invest in equities. However, nowadays two options are becoming increasingly popular for investing in equities, especially for those who lack any such skills or cannot devote much time to their research on companies.
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These two options are Mutual funds and ETFs (Exchange traded funds). These two investment vehicles have quite a few similarities, which might confuse investors. However, there are some key differences that set them apart from each other and depending upon the goals of the investor, one might be more suitable than the other.
So, what are mutual funds?
A mutual fund is an investment vehicle, which is basically made up of a pool of investments from retail investors. They pool their contributions into a large fund, which is managed by a dedicated fund manager who aims to deliver a return not less than the benchmark. A mutual fund generally invests in two asset classes, i.e., debt and equity.
A mutual fund involves high management fees, charged by the AMC (Asset Management Company). Most of the mutual funds are not traded on an exchange, making it difficult to enter and exit. Also, the price of a fund, called NAV (Net Asset Value), is published by the AMC after the end of the day. This takes a backseat compared to the price of an ETF, which is displayed on a real-time basis.
What is an ETF?
An exchange traded fund (ETF) is like a mutual fund in the sense that it is also a pooled investment of retail investors, being channelised by an investment professional to deliver decent gains. However, unlike mutual fund, most of the ETFs are passively managed funds, costing only a fraction of management fee than what a mutual fund company charges.
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As ETFs are passively managed funds, their aim is not to outperform the benchmark but to closely track its performance to deliver a return as close as possible to that of the benchmark. An ETF also has various underlying assets such as stocks, bonds, commodities, currency, index, etc. Unlike mutual funds, ETFs are traded on an exchange and therefore can be bought/sold in real time without having to wait for the price at the end of the day.
Read More: Are ETFs better than Mutual funds?
So, which one is a better option?
As mentioned earlier, the choice of investment vehicle depends upon the goals of an investor. Let us have a brief look at the key differences between the two to help you understand which one could be a better option for you.
ETFs are passively managed funds and closely track the return of the underlying asset. On the other hand, mutual funds can be both passive and active funds, with actively managed funds aiming to outperform their benchmark. If you are a conservative investor, ETFs are an ideal choice. However, investors with higher risk appetite can seek potentially higher returns via a mutual fund.
- Ease of transaction
Buying a mutual fund could be a cumbersome process, as you have to apply with the respective AMC. However, buying an ETF is relatively simple – as easy as buying a share from a stock exchange. And the same goes for exiting your investment.
The management fee in an actively managed mutual fund could be quite high and can significantly eat into profits over the long run. The low cost ETFs are an ideal choice for long-term investment to replicate gains of the underlying.
- Risk appetite
Risk appetite plays a major role in selecting the type of investment fund. If you have a high risk appetite, then you can go for higher risk funds such as a small cap mutual fund, which could potentially lead to high returns. If you cannot take much risk and are satisfied with average gains, then ETFs are the way to go.
- Types of funds
Mutual funds come in various flavours such as sector specific funds, market capitalisation-based funs (small-cap, mid-cap, etc.). They also come mixed with bonds or bond funds alone, which helps to manage risk of the entire portfolio. ETFs generally track a single commodity/index.
However, there are variations as well such as leveraged ETFs, which give higher exposure to the underlying than the invested value, or an inverse ETF, which is inversely co-related to the underlying.