26 Feb, 2025
4 mins read
Mutual funds and exchange-traded funds (ETFs) are two common investment options in today's financial markets. When exploring investment options, many investors find themselves wondering about ETF vs mutual fund choices. Both investment methods combine money from multiple investors to purchase a variety of stocks and bonds. In this article, we will understand what are ETFs and mutual funds, the key differences between them, and their advantages.
Mutual funds are investment tools that pool money from multiple investors to buy a mix of stocks, bonds, and other securities. These funds are managed by financial professionals who research and select investments on your behalf. Investors own small portions of all the investments in the fund. The fund's portfolio is diversified across different assets/stocks to reduce risk and increase returns.
ETFs are investments that combine features of mutual funds and stocks. These funds trade on stock exchanges with prices fluctuating throughout market hours. Each ETF share represents ownership in a portfolio that is designed to track specific market indices like Nifty or Sensex.
These investment options focus on matching market performance rather than outperforming it. ETFs usually allow more flexibility than mutual funds since you can buy and sell them anytime during market hours.
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ETFs |
Mutual Funds |
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Investors can buy and sell ETFs through their brokerage accounts with real-time price visibility, similar to trading individual stocks. |
Mutual fund transactions occur directly with the Asset Management Company (AMC) or through an intermediary rather than on an exchange. All buy and sell orders placed during the day are processed at a single price calculated after market close. |
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Investors can enter and exit positions at any time during market hours without facing lock-in penalties. |
Certain Mutual Fundss come with minimum holding periods called lock-in. It could range from a few days to several years. Early redemption triggers penalties. |
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ETFs follow a passive investment approach where the fund tracks a specific index (like Nifty or Sensex). This means minimal intervention from fund managers and lower overhead costs. |
MFs house employ professional fund managers who make investment decisions, conduct research, and adjust portfolio holdings based on market conditions. |
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The initial investment can be as little as ₹100. |
SIP investments in Mutual Funds typically start with ₹500 initial investment. |
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ETFs offer advanced trading options like limit orders, stop-loss orders, and margin trading. |
MFs are limited to basic buy and sell orders at the end-of-day NAV price. They don’t come with the ability to place sophisticated trade orders or implement advanced trading strategies. |
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ETFs have lower expense ratios due to their passive management style and reduced operational costs. |
MFs carry higher expense ratios due to active management and operational costs. |
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As ETFs mirror components of an index, investors can see exactly what the ETF owns at any given time. |
MFs are bound to declare their holdings only once a quarter. |
ETFs are cheaper than actively managed funds. This means you pay less in fees to own them. For mutual funds to be worth it, they need to perform better than ETFs to compensate for their higher costs. Over many years, the lower costs of ETFs can add up to significant savings for investors.
Investing in ETFs is straightforward. Unlike mutual funds, you don't need to study past performance records, research fund manager strategies, or analyse how funds perform in different market conditions. Instead, you simply choose an index you want to track and pick an ETF that follows it.
ETFs are a smart way to invest your money across many different investments at once. Instead of buying individual stocks, you can buy a single ETF that tracks an index. This is helpful because as ETFs invest in a wider basket of stocks, they provide you with the inherent benefits of diversification.
You can trade ETFs any time during the day when the market is open. This makes ETFs very convenient because you can easily convert them to cash when you need to. If the market is going up or down quickly, you can buy or sell your ETFs right away at the current price. However, some ETFs tracking lesser-known indices can be illiquid at times.
While mutual funds and ETFs come with their sets of advantages and disadvantages, you need to gauge your risk appetite and the need for liquidity while investing in ETFs or Mutual Funds.
ETFs and mutual funds each have their advantages. ETFs tend to be more tax-efficient since you only pay capital gains when selling. Mutual funds offer professional management and typically cost more. Your choice depends on your investment goals and preferences.
ETFs and mutual funds are taxed based on their type and nature of income. Dividend income from ETFs and mutual funds are taxed at your slab rate and capital gains are taxed as per the type. Capital gains from equity mutual funds and ETFs allow an exemption of Rs 1.25L in a year beyond which they are taxed at the rate of 12.5%. Capital gains from Debt mutual funds and ETFs are taxed at your slab rate.
ETFs usually cost less than mutual funds, with yearly fees of 0.1% to 0.7%. Mutual funds, especially actively managed ones, tend to be more expensive with expense ratio fees of 1% or higher.
Both ETFs and mutual funds spread risk through diversification. Neither is automatically safer than the other. The actual risk depends on what investments they hold and how you use them.
Calculate your Net P&L after deducting all the charges like Tax, Brokerage, etc.
Find your required margin.
Calculate the average price you paid for a stock and determine your total cost.
Estimate your investment growth. Calculate potential returns on one-time investments.
Forecast your investment returns. Understand potential growth with regular contributions.
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