ETFs Vs Mutual Funds: Understanding The Key Differences

Exchange-Traded Funds (ETFs) and mutual funds are both popular investment vehicles. But which one is right for you? This guide will break down the key differences between ETFs and mutual funds, helping you make informed financial decisions. We’ll cover what ETFs are, how to invest in them, and whether ETFs are riskier than mutual funds. We will also explore the different types of ETFs available to suit various investment strategies.

Let us discuss ETFs vs mutual funds with the help of ten common questions:

What Is ETF

Imagine an investment basket that gives you exposure to a wide range of stocks, bonds, or commodities. That’s an ETF (Exchange Traded Fund)! Unlike mutual funds, ETFs trade on the stock market, making them as flexible as individual stocks.

Think of ETFs as tracking specific goals, like the S&P 500 or a particular industry. They aim to mirror the performance of their chosen target, offering a convenient way to diversify your investments. 

What Are ETF Types

1. Index ETFs: These ETFs track a specific market index, like the S&P 500 or the Nasdaq-100. They’re a great way to invest in the overall market without picking individual stocks.
2. Sector ETFs: Want to focus on a particular industry? Sector ETFs target specific sectors like pharma, technology, information technology, or energy.
3. Thematic ETFs: These ETFs invest in companies related to a specific theme or trend, like clean energy, artificial intelligence, or electric vehicles.
4. Commodity ETFs: If you are interested in commodities like gold, or silver, commodity ETFs can provide exposure without the hassle of physical ownership. Examples for commodity ETFs are gold ETFs and silver ETFs.
5. Bond ETFs: For those seeking fixed-income investments, bond ETFs offer exposure to various types of bonds, including government bonds, corporate bonds, and emerging market bonds. 

What Is Mutual Fund

As the component of its name ‘mutula’, a mutual fund is like a shared investment pool. It collects money from different investors and uses it to buy stocks, bonds, or other securities. Unlike ETFs, mutual funds are actively managed by professionals who make investment decisions based on the fund’s strategy.

There are two main types of mutual funds, viz., actively managed and passive mutual funds. Actively managed funds aim to outperform the market, while passively managed funds track a specific index, similar to what is ETF.

What Is ETF Types

1. Equity Funds:

• Goal: Capital growth
• Investments: Primarily stocks
• Best for: Investors seeking long-term growth

2. Bond Funds:

• Goal: Income
• Investments: Bonds
• Best for: Investors seeking a steady income stream

3. Money Market Funds:

• Goal: Safety and liquidity
• Investments: Short-term, low-risk securities
• Best for: Investors seeking a safe place to park their money

4. Balanced Funds:

• Goal: A mix of growth and income
• Investments: Stocks and bonds
• Best for: Investors seeking a balanced approach to investing

5. Index Funds:

• Goal: Tracking a specific market index
• Investments: Stocks or bonds that mirror a particular index
• Best for: Investors seeking a low-cost way to invest in the overall market

6. Commodity Funds:

• Goal: Gaining exposure to commodity trading and price movements of physical goods
• Investments: A mix of commodities such as gold, oil, natural gas, agricultural products, or commodity futures contracts
• Best for: Investors looking to diversify their portfolio through commodity trading and hedge against inflation

How To Invest In ETF

To invest in ETFs, start by opening a brokerage account that offers a wide range of ETF funds and allows for easy transactions. Choose a brokerage that aligns with your investment style and budget. Once you have an account, research and select an ETF that matches your investment goals. Consider factors such as the ETF’s expense ratio, track record, and underlying holdings.

When you’ve found the right ETF, place your order. ETF funds trade like stocks, so you can buy at the current market price or set a limit order to specify the price you’re willing to pay. After purchasing your ETF, regularly monitor its performance and market conditions. You may need to rebalance your portfolio periodically to maintain your desired asset allocation.

Key Considerations:

• Expense Ratio: The expense ratio is the annual fee charged to manage the ETF. Lower expense ratios generally result in higher returns.
• Underlying Holdings: Examine the specific securities held by the ETF to understand its exposure to different assets.
• Liquidity: Ensure the ETF is liquid, meaning it can be easily bought and sold without significant price fluctuations.
• Tracking Error: This measures how closely the ETF tracks its underlying index. A lower tracking error indicates better performance.
• Tax Efficiency: Consider the tax implications of holding the ETF, especially if you’re in a high-tax bracket.

By following these steps and carefully considering the factors mentioned above, you can effectively invest in ETFs and potentially achieve your financial goals.

What Makes ETFs different

Here are some of the key points of difference between ETF and mutual fund:

ETFs (Exchange-Traded Funds) can generally be more cost-effective and offer greater flexibility than other mutual funds. They trade on stock exchanges like individual stocks, allowing investors to buy and sell shares throughout the trading day. ETFs are often passively managed, tracking specific indexes or asset classes, which can result in lower expense ratios.

Mutual Funds, on the other hand, can have higher expense ratios, especially actively managed funds. They trade at the end of the trading day based on their net asset value (NAV). Mutual Funds can provide active management and diversification benefits, but they may also have redemption restrictions or delays, especially for smaller or less liquid funds.

Are ETFs Mutual Funds

Yes, ETFs are a type of passive mutual funds. 

What Are Benefits Of ETFs

Lower costs: You can save more on fees with their lower TER (Total Expense Ratio).

Transparent: With ETFs, which are a type of passive mutual funds, you know what you’re investing in.

Liquid: You can buy and sell ETF units easily in stock exchanges.

Diversified: You can diversify or spread your risk by investing in different assets

Accessible: You can invest with ease and trade just like stocks.

What Is Mutual Fund Risk In ETF

ETFs can be riskier if they track volatile sectors or commodities. Their prices can fluctuate more during the trading day, similar to individual stocks.

However, risk is subjective and depends on your investment goals and risk tolerance. Do your research before investing.

How To Choose Between ETFs And Mutual funds

The better choice between ETFs and mutual funds depends on your individual goals and comfort level with risk. If you prioritise lower costs, flexibility, and the ability to trade anytime, ETFs might be a better fit. But if you prefer professional management and don’t mind higher fees, mutual funds could be a good option.

Conclusion

ETFs and other mutual funds both offer diversified investment opportunities, but they have different characteristics. ETFs are known for their lower costs, flexibility, and tax efficiency, as they trade on stock exchanges like individual stocks. You should carefully consider your investment goals, risk tolerance, time horizon, fees, and tax implications to determine whether ETFs or other mutual funds are suitable for each of your financial goals. Open demat account online at zero brokerage with HDFC Sky now and invest in securities of your choice with ease.