What Is Better: Mutual Funds vs ETFs?

Investors are fond of investment options where they gain high investment returns and grow their invested capital without too much involvement. Particularly for new investors having guidance from finance experts in choosing stocks and securities is always a priority. For this reason, mutual funds entered the investment market some decades ago, where multiple investors come together to pool funds across various asset classes, such as equity, gold, debt, and other securities.

Some years back, ETFs also started becoming popular. Like mutual funds, ETFs also pool funds from various investors and use those funds to purchase various assets, such as shares and securities. Both mutual and exchange-traded funds (ETFs) are beneficial to enhancing one's financial portfolio, including instant diversification at a minimal cost.

Mutual funds and ETFs are similar in their core characteristics but are also uniquely different in some key ways. This is why most new investors struggle with mutual funds vs ETFs and which one to choose. This article thus talks about ETFs vs mutual funds (i.e., their similarities and differences) to illuminate investors about what could be an ideal choice for them per their requirements.

What Are Mutual Funds?

Mutual funds have been there for around a century. The first mutual fund was launched in 1924. Mutual funds can be grouped as one of the older ways of pooling money from various investors to own shares and securities in a larger portfolio.

Most mutual funds are actively managed. In other words, mutual fund managers make decisions about where and how to allocate the concerned assets in the fund.

Mutual funds can be classified into different types based on the type of asset class invested. Some widely popular categories of mutual funds are debt mutual funds and hybrid mutual funds.

What are Exchange Traded Funds (ETFs)?

Exchange-traded funds are comparatively new entrants that penetrated the investment arena a few decades back. The first launched ETF was the SPDR S&P 500 ETF Trust in January 1993.

When launched, ETFs were passively managed, as they were typically managed like index funds. In other words, the assigned fund managers do not choose the investment to be held.

Rather, these funds mimic a list of investments. This trend has recently changed with a growing body of actively-managed ETFs offered to investors.

Mutual Funds Vs. ETFs: A Comparison Overview

Mutual funds have been here for decades. On the other hand, ETFs have recently penetrated the investment scenario. In recent times, there have been extensive debates concerning exchange-traded funds or ETFs as one of the best investment channels.

New investors may assume ETFs to be the same as mutual funds because ETFs also pool money from different investors to trade stocks and securities. There is no argument that ETFs and mutual funds have much in common.

However, ETFs are not the same as mutual funds. Here in the battle of mutual funds vs ETFs, we will see how exactly mutual funds differ from ETFs and vice-versa. Let us first begin with how mutual funds and ETFs are alike.

Mutual Funds vs ETFs: Similarities

Here are the two key similarities between ETFs and mutual funds.

Mutual Funds vs ETFs: Similarity in Structure

The primary similarity between mutual funds and ETFs is that both represent the pool or basket of individual securities. For example, in both cases, capital is pooled using different investors.

Mutual Funds vs ETFs: Exposure to Assets Classes

Both ETFs and mutual funds are known to offer access to a wide range of asset classes and niche financial markets. Unlike other stocks or bonds, mutual funds and ETFs provide richer diversification. They can be utilised to create a diversified portfolio, especially when capital from multiple asset categories is combined.

Mutual Funds vs ETFs: Differences

Now that investors know the similarities between mutual funds and ETFs, it is time to delve into the key differences between mutual funds and ETFs.

Mutual Funds vs ETFs: Management of Funds

ETFs tend to be passively or actively engaged by investment fund managers. Those ETFs that are passively traded and managed are based on the performance of the particular index.

Unlike ETFs, most mutual funds are actively managed by the fund managers, and they decide which assets to invest in and where. However, they are also offered in both active and indexed varieties.

Mutual Funds vs ETFs: Trading of Funds

ETFs are brought and sold on a stock exchange. ETFs are subject to price changes throughout the trading day. In other words, the price at which an investor buys an ETF is highly likely to differ from that of other competitors' prices.

On the other hand, mutual funds can only be sold and brought once a day, usually at the end of the day. This means all traders will receive mutual funds at the same price on the same trading day.

Mutual Funds vs ETFs: Minimum Investment

Since ETFs are traded like stocks, they do not require investors to invest a minimal amount. Instead, they are purchased as whole shares. Investors can buy an ETF for the market price of just one share.

On the contrary, mutual funds require minimum initial investments. The minimum amount varies among investment agencies. Mutual funds are not based on the fund's share price and can be purchased in fractional shares or the fixed INR amount.

Mutual Funds vs ETFs: Associated Costs

ETFs, come with both implicit and explicit costs. The investment broker will disclose the cost associated with trading commissions. Likewise, the ETF provider will also disclose the OER or operating expense ratio. However, it is recommended that investors should seek a premium discount to Net Asset Value or NAV.

On the other hand, mutual funds are available to be purchased without trading commissions. Nonetheless, they also carry other fees, such as early redemption fees or sales loads fees.

Mutual Funds vs ETFs: Tax Efficiency

Since ETFs have lower turnover and use in-kind creation or redemption processes to manage the holdings' cost, ETFs may be prone to generating fewer capital gains for traders.

On the contrary, mutual funds may offer higher capital gains for shareholders for the sale of securities. This is also valid for those investors who may have incurred a loss on the overall investment of mutual funds.

ETF vs Mutual Fund: Features

Investors can buy diverse assets depending on whether they buy an ETF or a mutual fund. The table below simplifies the features allowed by mutual funds and ETFs:

Conclusion

Mutual funds and ETFs are ideal investment options for investors aiming to grow their investments. So, which one is better? Well, there is no better choice when it comes to ETFs vs mutual funds. The choice between which investment option to choose is contingent upon the convenience and requirements of the investors. For instance, if the investor has a brokerage account, buying an ETF would be an ideal and convenient option.

However, it is preferable to choose mutual funds if the investor does not have a brokerage account. Likewise, ETFs allow investors who frequently trade to engage in intraday trades, limit orders, and short-selling. Now that investors are aware of the mutual funds vs ETFs battle, they may now begin engaging in a rewarding investment experience.

Frequently Asked Questions (FAQs)

What are mutual funds?

Mutual funds are investment schemes that pool capital from various investors to be further invested by a professional fund manager. The professional fund manager is eligible to invest the pooled capital to purchase different securities, such as stocks, gold, bonds, or any combination of these. Different mutual funds follow different investment objectives. The fund manager's job is to allocate the assets between stocks and bonds wisely.

What are exchange-traded funds?

Exchange-traded funds, or ETFs, are investment fund schemes traded on the stock exchange. The assets that fall under the umbrella of ETFs are stocks, bonds, and commodities.

When it comes to ETFs vs mutual funds, which option is better if someone invests frequently?

Ans. If investors tend to make regular deposits, they should consider opting for ETFs. Unlike mutual funds, ETFs allow investors to make daily investments and engage in other facilities, such as limit orders or short-selling.

How much is the GST rate applicable to mutual funds or ETF investments?

Ans. Effective from July 1, 2017, a GST rate of 18% is applicable for any investment and financial services. ETFs offer better tax benefits than mutual funds. Thus investors aiming for tax efficiency should focus on passively managed ETFs.