A lot of young people like to spend their money and get great returns fast. The hardest thing for an investor to do is choose between mutual funds and exchange-traded funds (ETFs). Investors put their money into a lot of different stocks, bonds, and other assets, and these tools pool that money.
Anyone can buy or sell ETF shares on the stock market and do so whenever they want. The market price of these shares can be seen right now, just like the price of any other share. If you want to buy or sell mutual funds, you have to send a request to the fund houses.
Not only that, mutual funds also have holding periods starting from 90 days to 3 years, where if you purchase or sell the share in the period, you need to pay a severe fine. Read below for the remaining post on knowing the differences between mutual funds and ETFs.
What are Mutual Funds?
Understanding mutual funds may be difficult or complex. We are going to simplify things for you. Mutual funds are collective investment vehicles that combine money from several participants(Investors). Investors combine their funds in a mutual fund to buy a range of assets, including bonds and equities. Asset Management Companies (AMCs) or Fund Houses are set up by companies that are allowed to start mutual funds. Investors put money into these companies, which then sell mutual funds, handle investments, and help investors do business with each other.
Compared to ETFs, mutual funds usually have higher minimum investments. Moreover, the investment can have different minimum requirements that will change depending on the company and the fund scheme. Most mutual funds use active management, which means that an expert fund manager or team of managers decides when to buy and sell to get the best results for the owners. Such funds entail a high cost as they need more effort, processing time, and expertise. Additionally, the investors purchase and sell mutual funds directly from and to the fund. So, before the close of the trading day, you need to know its NAV(Net Asset Value) before you can know how much a mutual fund is worth.
Types of Mutual Funds
The four classifications of mutual funds are: -
Every one of these mutual fund types has risks and the chance to make money in the market as a whole, but some are riskier and have bigger possible benefits.
Mutual Equity Funds Benefits
- Diversification: Diversifying investments through mutual funds is easier because the money is spread out among different types of assets. This lowers the risk of losing money when certain areas don't do well.
- Professional Management: Professional fund managers keep this type of stock in check by changing investments based on the fund's goals, which is good for buyers in this group.
- Tax Benefits: Section 80C of the Income Tax Act, of 1961 lets people get tax breaks for investing in ELSS (Equity Linked Savings Scheme) funds.
- Liquidity: They can sometimes be redeemed right away by their owners, making them suddenly real.
- High Return: Mutual funds invest in a combination of sectors and industries, and hence, one can expect higher returns over the long term, which is more than inflation.
- Well-regulated: In India, regulatory bodies like SEBI regulate the mutual fund industry, safeguarding investors and ensuring transparency.
- Ease of Investing: We might also discuss the straightforward nature of mutual fund transactions. The mutual fund route comes in online and offline forms, making purchasing and selling through asset management companies easier.
- SIP and Lump Sum Investments: There are many ways to invest, ranging from a low-cost Systematic Investment Plan (SIP) to a lump sum, so buyers of all sizes can take part in anyone which ever suits them.
What are ETF Funds?
An ETF is a group of stocks that you can buy and sell on the stock market through a trading company. An exchange-traded fund (ETF) tracks almost every type of asset, from what are thought to be "traditional" investments to so-called "alternative" investments like currencies or commodities. New ETF designs let buyers borrow money, sell short on the market, and make short-term cash gains that aren't taxed. When buying an ETF, you usually only need to put in a small amount. Investors only have to pay for one share and the fund house's fees. Furthermore, they are generated by institutional investors in significant quantities - furthermore, the shares are traded continuously throughout the day, similar to stocks.
ETFs, like stocks, can be sold short. However, it is a useful tool for the spectacular and the trader, but not for long-term investors. As we know, the market constantly rates ETFs, and there is always the possibility of trading at a value which is much greater than the real NAV.
Furthermore, ETFs provide significant tax savings to investors. However, they generate less capital gains than mutual funds because they are passively managed.
Benefits of Exchange Traded Funds
The following are the key Exchange Traded Funds benefits:
- Depending on their needs, investors can buy and sell ETFs on credit or short, which involves higher risk and are subject to regulation and the broker’s policies.
- Since there is no minimum investment level, an investor can buy a single share if necessary.
- It is actively bought and sold, and the value keeps changing through the trading day. Even transactions can be done in real-time.
- As with the other index fund categories, ETFs can exchange the underlying securities at the time of unit subscription and redemption, not cash.
What is the difference between ETF and Mutual Fund?
| Basis | Mutual Funds | ETFs |
| Trading Value | Mutual funds are traded at the closing NAV (Net Asset Value) | ETFs are traded anytime during the trading day, and their prices keep changing. |
| Operational Fee | Mutual funds have slightly higher operating fees. | ETFs come with lower expenses. |
| Minimum Investment Requirement | Mutual funds require a minimum investment. | There are no minimum requirements in the case of ETFs. |
| Taxation | Mutual funds come with tax liabilities. | ETFs offer multiple tax benefits to investors because of the way they are redeemed and created. |
| Trading Mechanism | You can only buy mutual funds directly from the funds, and their Net Asset Value stays the same during the trading duration. | Exchange-traded funds (ETFs) may be bought and sold at any moment based on their current market value. |
| Transaction Costs | When mutual funds are purchased or sold, they bear no transaction costs. | There are additional charges involved while trading ETFs at various stock exchanges. |
| Liquidity | Mutual funds have lower liquidity, unlike ETFs. | ETFs have more liquidity because they do not require daily trading volume. Their liquidity is derived from the liquidity that is there in stocks. |
| Selling Time Limit | Many mutual funds impose a penalty or fine on selling the shares before the fixed period. Usually, this time limit is levied on selling shares 90 days from the date of purchase. | On the other hand, ETFs do not have any specified buying or selling time. Investors can buy or sell them anytime they want. |
| Management | Expert fund managers or teams are both actively managing mutual funds and keeping an eye on the index. When this happens, assets are picked so that they do better than the average. | ETFs, on the other hand, follow averages. They try to get the same profits and price changes as the index. |
Which is better to invest ETF or Mutual Funds
Both the above-discussed investment options could help to build an excellent investment portfolio to gain better returns from investment. However, both carry perks and drawbacks that should be considered when picking one. The selection depends entirely on your proper financial goals, experience levels, and risk appetite, among other factors. Prior to choosing the best choice, consider the following inquiries:
- How much risk are you willing to take?
- What worries you about liquidity?
- What are your financial objectives?
- How long do you plan to invest?
- What are your initiatives for reducing taxes?
Once you answer these questions, you can make up your mind regarding what the right option is. Regarding mutual funds, you shall be asked to be invested for the long term, but it will help generate better returns for the future. But if you are flexible in handling your funds and willing to stay for a while, then an ETF could be a good offering. It is your choice, but you should avoid it for your benefit. So, stay tuned to this article to find the right way to choose an investment option.
Conclusion
Both mutual funds and ETFs bring vast investment opportunities for young investors. This means it helps build an excellent investment portfolio, giving better results. Nevertheless, you have to weigh the benefits and drawbacks before selecting one. Whatever option you choose will rely on a number of factors, including the investor's investment style, acceptable fees, and financial objectives.