The age old debate never seems to settle – What is better, mutual funds or exchange traded funds (ETFs)? Seasoned investors have presented their points and so have mutual fund pundits, but even today young investors find it difficult in determining which type of investment product is more suitable for their investment portfolio. Some may argue that there aren’t many differences and these two are almost identical while others may beg to differ and claim each one of them to have their own uniqueness.
So, what is it that makes it difficult to choose between the two? Or should investors consider both mutual funds and ETFs for their investment portfolio? To find this out they first need to understand each of these investment products briefly.
What is an exchange traded fund?
Commonly referred to as ETF by investors, an exchange traded fund is an open ended scheme that can be bought just like company stocks over the stock exchange through a broker. It is a one-of-a-kind mutual fund scheme whose units are traded at their live market price at the stock exchange. The live market price of an exchange traded fund does not deviate much from its NAV (Net Asset Value). However, investors can enter or exit exchange traded funds as many times as they throughout the day till the market is live. Basically, you can be involved in intraday trading with ETFs or wish to remain invested for the long haul. ETFs are more affordable than mutual funds because one can start investing in them by buying a single unit that usually costs a few hundred rupees. There are two primary ways in which investors can generate with ETFs, either through dividends or through interest earned over the investment period. An exchange traded fund invests a minimum of 95 percent of its investible corpus in the underlying securities of its benchmark whose performance it tries to replicate with minimum tracking error.
Investors need a demat account to park their bought exchange traded fund units. Without a demat account, one cannot trade in ETF schemes. ETFs do not have a lock-in period which is what makes them highly liquid. An investor can liquidate their portfolio at any given time by selling their ETF units and book profit when the value of these units is more than its purchase price. Since exchange traded funds are passively managed, they usually have a low expense ratio. However, since you trade ETF units at the stock exchange, additional transaction costs might be involved. The investor has total control over his or her investments.
What are mutual funds?
A mutual fund is a pool of professionally managed funds that spread its assets across various securities, asset classes, and money market instruments. Asset Management Companies that own mutual funds pool financial resources from investors sharing a common investment objective and invest this pool of funds in diversified holdings. Mutual funds are actively managed by fund managers who buy and sell securities on behalf of the investors. Investors do not need to have any expertise or have a deeper understanding of the markets. They just need to identify a mutual fund scheme that is ideal for their financial goals and invest in it religiously till their investment objective is accomplished. One does not need a demat account to invest in mutual funds. Also, to buy or sell your fund units you need to place an order request to the AMC and you can buy or sell units depending on the scheme’s NAV which is determined at the end of the day.