Difference Between Mutual Funds and ETFs
Mutual funds refer to the investment schemes which are managed actively and professionally where the fund houses collect money of the different investors and then invest them in the various holdings in diversified area house whereas the ETFs (exchange traded funds) refers to the basket of securities which are traded on the exchange like a stock and these funds are passively managed and can be traded freely in the market from the exchange in which the same is listed.
A variety of investment avenues exist for investors to grow their money. Mutual fundsMutual FundsA mutual fund is an investment fund that investors professionally manage by pooling money from multiple investors to initiate investment in securities individually held to provide greater diversification, long term gains and lower level of risks. and ETF’s are two such modes that guide in multiplying investments made with a line of demarcation between them. Mutual funds involve a common financial goal whereby the asset management companyAsset Management CompanyAsset Management Company is a company that takes the financial assets of a person, company or another asset management company (generally this will be high net worth individuals) and use the assets to invest in companies that use those as a operational investment, financial investment or any other investment in order to grow the investment. will invest the funds accumulated in various securities in the capital and money marketsMoney MarketsThe money market is a market where institutions and traders trade short-term and open-ended funds. It enables borrowers to readily meet finance requirements through any financial asset that can be readily converted into money, providing an organization with a high level of liquidity and transferability.. They are considered to be a safe haven as they follow a given set of strategies with the aim of providing consistent returns above the market rate of return.
ETF’s on the other side is similar to Mutual funds but get traded on the stock exchangeStock ExchangeStock exchange refers to a market that facilitates the buying and selling of listed securities such as public company stocks, exchange-traded funds, debt instruments, options, etc., as per the standard regulations and guidelines—for instance, NYSE and NASDAQ..
Mutual Funds vs ETFs Infographics
Let’s see the top differences between Mutual Funds vs ETF.
- Mutual funds are a pool of investments from various investors, which will further invest in the stock market on behalf of the investors. The investment will be made in diversified securities with the objective of offering returns greater than the risk-free rateThe Risk-free RateA risk-free rate is the minimum rate of return expected on investment with zero risks by the investor. It is the government bonds of well-developed countries, either US treasury bonds or German government bonds. Although, it does not exist because every investment has a certain amount of risk. of return prevailing. On the other hand, an ETFETFAn exchange-traded fund (ETF) is a security that contains many types of securities such as bonds, stocks, commodities, and so on, and that trades on the exchange like a stock, with the price fluctuating many times throughout the day when the exchange-traded fund is bought and sold on the exchange. is an investment fund traded on the stock exchange. These ETFs track an index like the stock index/bond index.
- Mutual funds involve the trading of share proceeds from the fund house, whereas ETFs involve trading activities between two investors in the secondary market.
- The average expense ratio of mutual fundsExpense Ratio Of Mutual FundsMutual Fund Expense Ratio is the percentage amount charged by the fund manager in exchange of the services provided. The charges include management expense, advisory fees, travel cost, consultancy charges, however, brokerage cost for trading in excluded. is relatively higher since they are tracking multiple indexes and securities, whereas ETFs track a particular index and adopt a passive strategy, which further reduces the average expense ratio. This aspect can further improvise on the return on investments offered.
- Mutual funds are actively managed by the designated fund managers who are responsible for continuously buying and selling of securities to exceed the expected returns. ETFs follow a passive management style since they are matching a specific index and wait for the opportunity before making a decision.
- Any sale or redemption in a mutual fund leads to a higher level of capital gains tax in comparison to ETF’s. Thus, ETF’s have greater tax efficiency due to the structure which permits to substantially decrease or avoid capital distributions.
- A share trading accountShare Trading AccountThe Share Trading Account is a virtual account used for buying & selling securities (Bonds, ETFs, & Mutual Funds etc.) in the online stock market. is not mandatory while purchasing a mutual fund, but since ETFs are traded on the stock market, a share trading account becomes mandatory.
- Mutual funds are traded on the NAVNAVNet Asset Value is calculated by subtracting the total value of the entity's liabilities from the total value of its assets and dividing the result by the total number of outstanding shares., which is quoted at the end of the day, but an ETF is traded throughout the day, such as stocks.
- Mutual funds do not involve any brokerage fees but are applicable in the case of ETF.
Mutual Funds vs. ETFs Comparative Table
|Basis of Comparison||Mutual Fund||ETF’s|
|Meaning||It is an investment vehicle that is managed in a professional manner. The resources are pooled from multiple investors and traded on behalf of clients.||An investment scheme is tracking the index. They are further listed and traded on the exchange.|
|Management Style||Active but within limits as mentioned in the Prospectus||Passive style|
|The requirement of Trading Account||Not essential||Required for transactions|
|Tax burden||Capital gains tax is high due to frequent trading||Comparatively, the lower tax is imposed|
|Brokerage||Not applicable due to direct purchase of the funds||It is required to be paid|
|Expenses||High expenses ratio||Expenses are less since they are not actively traded, causing ratios of expenses to fall.|
|Trading activities||Occurs within the fund house||They executed to and from the investors in the markets.|
After the detailed discussion above, both are similar investment patterns with the aim being to maximize the profits from the investments received. Both have their pros and cons and depending on the risk-taking ability, and the desired strategy of the investors, either of the instruments can be pursued.
Another benefit is that both can be included in the individual portfolio to maximize returns.
This has been a guide to Mutual Funds vs ETFs. Here we discuss the top differences between them along with infographics and comparative table. You may also have a look at the following articles for gaining further knowledge –