ETFs and mutual funds: A comparative guide

Investing intelligently is vital but deciding whether to invest in an exchange-traded fund (ETF) or a mutual fund is perplexing. Both an ETF and a mutual fund aggregate funds from a group of investors and invest it in different assets. Although both are similar, their structure, management and trading mechanism are quite different. Knowing how an ETF is different from a mutual fund aids investors make an informed choice as per their financial needs.

What is a mutual fund?

A mutual fund pools investor money and invests in stocks, bonds or other securities. The portfolio is actively managed by a fund manager who chooses securities to achieve maximum returns. Mutual funds are valued on a net asset value (NAV) basis, which is computed daily at the close of the market. Investors buy or sell units at the NAV, but these are traded through the fund house, not the share market. Certain funds impose an exit load in case units are being redeemed within a given period.

What is an ETF?

An exchange-traded fund (ETF) is similar to a mutual fund but trades like a stock on an exchange. It passively tracks an index, commodity or sector, aiming to replicate its performance. Unlike mutual funds, ETF prices fluctuate daily based on market demand. Investors must have a Demat account to buy and sell ETFs. Since ETFs require minimal management, they often have lower expense ratios than actively managed mutual funds.

ETF vs mutual funds: How are they similar?

While mutual funds and ETFs have distinct structures, they share several features that make them attractive investment options. Here’s a look at their key similarities:

• Both pool money from multiple investors

ETFs and mutual funds collect money from numerous investors and allocate it across securities such as equities, debt instruments or commodities like gold. Professional fund managers oversee these investments.

• Both offer diversification

Since ETFs and mutual funds invest in multiple securities, they help mitigate risk. If one asset underperforms, another may compensate for the loss, reducing overall volatility compared to investing in individual stocks.

• Both follow passive investment strategies

ETFs and index mutual funds follow a passive investment strategy, replicating a specific index instead of trying to outperform it. This, thus, ensures lower costs and market-aligned returns.

• Both provide professional management

Financial experts oversee both ETFs and mutual funds, whether actively or passively managed. Fund managers ensure the portfolio aligns with investment objectives and track performance relative to benchmarks.

• Both have NAVs

Like mutual funds, ETFs have an NAV (Net Asset Value) calculated at the end of the day. However, ETF prices fluctuate during market hours based on investor demand.

Mutual funds vs ETFs: Key differences

While mutual funds and ETFs offer diversification, they differ in trading, pricing, management and cost structure.

Ending note

Both ETFs and mutual funds help investors diversify risk and generate returns. ETFs offer intraday liquidity, lower costs and passive investing, making them ideal for cost-conscious investors.

Mutual funds provide active management and SIP options, making them suitable for long-term wealth creation. Choosing between the two depends on individual financial goals, investment style and market knowledge.