Difference between ETF and Mutual Funds?

What are ETFs?

ETF mutual fund or ETF schemes track a benchmark index, example – Sensex or Nifty, etc. ETFs do not aim to beat benchmark index returns; rather they aim to replicate the performance of the benchmark index.

ETF vs mutual fund?

There is always a debate before investing between ETF vs mutual fund. Most mutual fund schemes are actively managed by professional fund managers with an objective to outperform the scheme benchmark index return and generate alpha for investors.

ETF mutual fund do not aim to do the above, they simply track the benchmark index and try replicate the benchmark returns. If you invest in an ETF mutual fund, chances are that you will get the benchmark return subject to the tracking error. Also, expense ratios of ETFs are much lower than mutual funds.

The above two are very important points to consider in terms of ETF vs mutual fund debate.

Difference between ETF and mutual funds?

Following is the difference between ETF and mutual funds.

  1. Buy/Sell - While ETFs can be bought and sold on stock exchanges during the trading hours, mutual fund can be bought or sold by applying to the mutual fund company either online or by filling up the physical form.
  2. Price - When you are buying or selling the ETF mutual fund, the price you pay is the real time trading price on which the ETF is being traded, this price may or may not be the actual price, known as NAV. But in case of mutual funds, the buy sell price (NAV) is applied at the end of the day based on the NAVs declared.
  3. Lock-in period – For ETFs, there is no lock-in period. But in case of mutual funds, exit load may be applied.
  4. Cost – ETFs are low cost products as they are passively managed whereas mutual funds are generally actively managed, therefore, the cost (expense ratio) is comparatively high.
  5. Commission/ Brokerage – For ETFs, you pay the trading commission and demat account charges. In case of mutual funds, though there are no charges for demat and trading, a commission is paid to the mutual fund distributor (in case of growth option) from the expense ratio charged by the AMC.
  6. Demat account – Demat account is must to buy ETFs. But in case of mutual funds, having a demat or trading account is not necessary.

Which is better ETF or mutual fund?

We discussed above the difference between ETF and mutual funds. Let us now see which is better ETF or mutual funds.

  • If you compare ETF vs mutual fund TERs (Total Expense Ratio), the TERs of ETF mutual fund is much lower compared to mutual funds, therefore, they will have a cost advantage over mutual funds.
  • If you have Demat and trading account you can invest in ETFs. If you do not have Demat account and do intend to open one, you can invest in mutual funds.
  • In extreme market conditions, you may face issues selling the units of ETF mutual fund as they are less actively traded and also that the trade price may be significantly lower sometime from the actual price (NAV). If you invest in mutual funds, you will always be able to redeem units at applicable NAVs.
  • For ETFs asset management companies do not provide systematic investment plan (SIP) facility. Therefore, if you are planning to invest through SIPs, then you will have to invest in mutual funds.
  • Both ETFs and mutual funds are very similar products, but you must consider the above facts about ETF vs mutual fund and take an informed decision before investing in ETF or mutual funds.

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