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ETF vs. Mutual Fund: Which is better and what's the difference?

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ETF vs. Mutual Fund
December 26, 2023

Table of Content

 

ETFs (Exchange Traded funds) and Mutual funds share many similarities, such as both being composed of a variety of assets and being a good way to diversify investments. However, there are differences between ETFs and mutual funds; ETFs can be bought and sold during the day like stocks, whereas mutual funds only have their value determined at the end of the day based on the Net Asset Value.

What is ETF?

Exchange Traded Funds (ETFs) are passive investment plans that seek to match the performance of an index. They are not managed by portfolio managers and do not try to beat the index they are tracking. ETFs can be easily bought and sold on a stock exchange and their price changes throughout the day depending on the Net Asset Value of the underlying assets that it contains. Different types of ETFs exist such as current ETF, bond ETF, inverse ETF, equity ETF, commodity ETF, gold ETF etc.

What is Mutual Fund?

A Mutual Fund is a professionally managed financial vehicle which pools funds from different investors. These funds are invested in a portfolio of assets such as stocks, government bonds, corporate bonds and money market instruments. An asset management company oversees the mutual fund and a team of experts and fund managers make investment decisions based on the fund's objective. 

Mutual funds offer the advantage of diversification and require less research and time than stock market investments. The market value of the portfolio is represented by the Net Asset Value (NAV), which is determined by the total net assets divided by the number of outstanding units. Mutual funds can be divided into equity funds, debt funds (Fixed income fund) and hybrid funds, depending on the types of assets they invest in.

How are ETFs and mutual funds similar?

ETFs (Exchange Traded Funds) and mutual funds have similar structures, the biggest similarity being that both of them represent a collection of individual securities such as stocks or bonds. Both offer access to a wide range of asset classes and niche markets, and they can be used to create a well-rounded portfolio when funds from multiple asset classes are combined, providing more diversification than investing in a single stock or bond.

Difference between ETF and Mutual Fund

 

ETFs

Mutual Funds

How are they managed?

ETFs can be actively or passively managed by fund managers, but most are passive investments linked to a particular index.

There are active and indexed mutual funds, but most are actively managed. Mutual funds managed by fund managers are active funds.

How are they traded?

Unlike stocks, ETFs trade on a stock exchange and experience price changes throughout the day. Therefore, the price you pay for an ETF may differ from the price paid by other investors.

Orders for mutual funds are executed once a day, and all investors receive the same price on the same day.

What's the minimum investment?

ETFs are purchased as whole shares because they trade like stocks and require no minimum investment. An ETF can be purchased for just one share, known as the "market price”.

Investment amounts for mutual funds are usually flat and don't depend on the fund's share price.

In contrast to ETFs, mutual funds can be purchased in fractional shares or in fixed dollar amounts.

What are the costs?

The costs of ETFs can be implicit or explicit. You should not overlook the bid/ask spread, premium/discount to NAV, and operating expense ratio disclosed by your broker and your ETF provider. The implicit costs result from buying or selling an ETF in the market at a price that may differ from the ETF's underlying value.

While mutual funds can be purchased without trading commissions, they may also charge other fees (for example, sales loads or early redemption fees).

What about tax efficiency?

Due to lower turnover and in-kind creation/redemption processes, ETFs typically generate fewer capital gains for investors.

If a mutual fund sells securities, shareholders may receive capital gains, even if the fund has an unrealised loss as a whole.

What are the similarities between ETF and Mutual Fund?

  • A diversified structure: Both of these funds consist of a basket of securities bought by money pooled from investors.

  • Professional management: ETFs and mutual funds are managed by professionals or management companies. Mutual funds and ETFs can either be actively or passively managed, although ETFs tend to be passively managed to track indexes.

  • Investor choice: Investing in mutual funds and ETFs offers investors a variety of asset types, such as stocks, bonds, commodities, cash-equivalent securities, or some combination of them.

ETF or Mutual fund - Which one to choose?

If you want to make a well-diversified investment portfolio, both mutual funds and ETFs can provide an ideal solution. However, depending on the time frame, risk appetite, and financial objectives, one of the two might be more suitable. Some investors tend to prefer liquid investments over long-term ones. Although both funds offer a diversified portfolio, an ideal balance between ETFs and mutual funds might provide further benefits. Therefore, before you take any action, it is important to gain an understanding of the respective investments, evaluate the market risks you're willing to bear, and consult a professional if necessary. 

Types of ETFs and Mutual funds

 

Passive ETFs

Active ETFs

Index Mutual Funds

Actively Managed Mutual Funds

Expense Ratio (OER)

The cost is generally lower than that of actively managed funds.

Generally higher than passive ETFs; comparable to institutional shares of mutual funds.

The cost is generally lower than that of actively managed funds.

The cost of actively managed, index-tracking funds is generally higher

Performance

Generally, performance is tracked by benchmark index

Performance strives to exceed the returns of a benchmark index.

Generally, performance is tracked by benchmark index

Performance strives to exceed the returns of a benchmark index.

Selection of Funds

Approximately 2,000

More than 700 actively managed ETFs and over 45 semi-transparent ETFs

Approximately 500*

Approximately 7,000*

Trading

Intraday

Intraday

End of Day

End of Day

Price

Market price

Market price

NAV (Net Asset Value) Tooltip

NAV (Net Asset Value) Tooltip

Holdings Transparency

Holdings generally reported daily

A semi-transparent ETF reports full holdings monthly or quarterly, whereas an actively managed ETF reports holdings every day

Holdings generally reported monthly or quarterly

Holdings generally reported monthly or quarterly

Alternate investment options

One other prevalent investment option you can choose is an ULIP. ULIPs help you to grow your wealth along with a life cover then you can consider ULIPs as an investment option. In ULIP Plan, the investment risk in the investment portfolio is borne by the policyholder.

Conclusion

Ultimately, ETFs and mutual funds are similar but have their own unique advantages and disadvantages. While they are both suitable for less risk-tolerant investors, it is important to know the associated market risks before investing in either one.

FAQs on ETF vs. Mutual Fund

Q. Is ETF better than mutual fund?

Ans. Exchange Traded Funds (ETFs) and mutual funds both offer diversification and professional management, but ETFs have lower fees, can be more tax efficient, and are more liquid. Therefore, one cannot precisely say if ETFs are better than mutual funds, although ETFs may be preferable to mutual funds, depending on your individual needs.

Q. Is SIP possible in ETF?

Ans. Yes, SIPs can be used to invest in ETFs. It allows you to invest a fixed amount at regular intervals, taking advantage of dollar-cost averaging. This helps to build a portfolio gradually.

Q. Is ETF better than mutual fund for short term?

Ans. ETFs are better than mutual funds for short-term investments because they trade throughout the day like stocks and can respond quickly to market changes, while mutual funds can only be bought and sold at the end of the day.

Q. Are ETFs cheaper than MF?

Ans. ETFs tend to have lower fees and transaction costs than mutual funds, as they are managed passively and incur lower management fees.

Q. Which ETF has the highest return in India?

Ans. ETFs with the highest returns in India depend on goals and risk tolerance. For long-term growth, consider a broad-based index fund ETF, such as the Nifty 50 ETF or the Sensex 30 ETF. For higher returns and higher risk, consider sector-specific ETFs, such as banking or infrastructure.

ARN - ED/12/23/7174

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Francis Rodrigues Francis Rodrigues

Francis Rodrigues has a decade long experience in the insurance sector, and as SVP, E-Commerce and Digital Marketing, HDFC Life, manages the online sales channel, as well as digital and performance marketing. He has had hands-on experience in setting up sales channels and functional teams from scratch over a career spanning 2 decades.

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Vishal Subharwal Vishal Subharwal

Vishal Subharwal heads the Strategy, Marketing, E-Commerce, Digital Business & Sustainability initiatives at HDFC Life. He is responsible for crafting and ensuring successful implementation of the overall organisation strategy.

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