In this article we will discuss about Mutual fund vs ETF. Which one is better? In Mutual fund vs ETF which you have to choose?
What is ETF ?
ETF or Exchange Traded Fund is a passively managed fund which simply tries to replicate an Index in terms of its investments as well as return performance. An equity ETF would pool in money from investors and invests in equities of various companies. The aim of the ETF is to generate similar returns as of the index. A person can’t avoid capital gains, but an investor won’t pay capital gains on their ETF shares until the final sale. ETFs can cost the investor less money in taxes.
Every time they sell or buy shares buyers pay a brokerage commission because ETF’s trade like stocks.
They have most of the benefits of index funds but with some benefits. The fees for ETFs are often cheaper than the index funds, and most likely will cost you less in taxes.
They calculate an ETF’s underlying net asset value by taking the current value of the fund’s net assets. (the value of all securities minus liabilities) then divide by total number of outstanding shares. The net asset value, called the NAV, is then published every 15 seconds through the trading day. But the ETF’s Net Asset Value is not actually its market price.
For example, a Nifty ETF will try to give you the same returns as the Nifty 50 and a Sensex ETF will try to generate the same returns as the Sensex 30. The strategy is to typically hold all the stocks of the underlying index in the same weights as they occupy in the index.
However, ETFs don’t necessarily just track stock indices. They can also track bond indices (such as liquid ETFs) or commodities (such as gold ETFs). (Mutual fund vs ETF)
Read here – What is Mutual Fund?
Features of ETFs
Actively Traded: Unlike mutual funds, ETFs are actively traded on a stock exchange. A mutual fund may be listed on an exchange, but is typically not actively traded. Hence an ETF price can differ from the underlying value of the ETF (called NAV). It can trade at a premium or discount to the NAV of the ETF. You also need a demat and trading account to invest in an ETF.
High Liquidity: Since ETFs are tradable securities, they are highly liquid. However, not all ETFs have the same liquidity on the stock exchange. In general large ETFs with significant assets under management, will have more liquidity. Therefore, It is better to invest in large ETFs over their smaller counterparts as they have higher liquidity.
Passively Managed: An ETF is necessarily a passive instrument which makes them free from fund manager’s error problem which is very much a possibility in mutual funds. Some ETFs can track customised indices such as the Nifty Low Vol Index or the Sensex Next 50 Index (called Smart Beta strategies). However, they are still passive instruments.
Lower Expense Ratios: ETFs are passively managed and hence have lower expenses than mutual funds. Exchange traded funds in India have expense ratio as low as 0.10%! Cost efficiency results in higher net returns over the long term.
Similarities Between ETF and Mutual fund:
- Diversification: ETF and Mutual funds provides benefit of diversification as both invest in different stocks, sectors, bonds, commodity etc.
- Professionally Managed: Both ETF and Mutual funds are managed by professionals. However some ETF’s are passively managed.
Differences Between ETF and Mutual fund:
- Trading and pricing: ETF are traded much like stocks since they are listed on the stock exchange also the price of ETF’s keeps on fluctuating just like stocks. Whereas Mutual funds are priced once a day after market close.
- Professional management: There are two kinds of ETF one which is actively managed by the professionals and another which is passively managed. Passively managed ETF do not aims to beat the benchmark index. Contrary to this most of the Mutual funds in India are actively managed by the professionals.
- Expenses: ETF’s are less expensive than mutual funds this is because ETF do not have exit load and operating expenses are also less when compared to mutual fund.
- Tax Efficient: When compared to Mutual fund, ETF are considered to be more tax efficient. This is because ETF are traded on the stock exchange and you buy and sell ETF’s and not the underlying securities.
Should you Invest in ETFs or Mutual Funds?
While comparing ETFs to mutual fund, you are essentially exploring the possibility that whether active management can beat indices in the long run. If you were to believe efficient market hypothesis, actively managed funds can not beat returns from index investing or exchange traded funds.
ETFs have been extremely popular in developed countries where it has consistently outperformed mutual funds. However, in the case of emerging market economies due to high growth potential, mutual funds have performed better than ETFs.
The biggest disadvantage with ETFs in developing countries is good companies in small and mid cap space with high growth potential are left out. However, in terms of risk, ETFs can be a better option as it invest in best of the companies of its space.
Therefore, if you are looking out for some kind of low risk-high returns type of combination, ETFs can be a great investment option for you.
However, if you are an individual willing to take moderate risk for earning higher returns and have long term investment horizon, mutual funds can be a great product for you.
Aside from this theoretical position, note that there is also one practical point to consider. You need a demat and trading account to invest in ETFs in India. If you are not comfortable with opening and maintaining these accounts, ETFs may not be appropriate for you. You can also invest in passive indices through index funds, rather than ETFs if you do not want to open demat and trading accounts.