Today’s investors have a variety of investment choices in the form of stocks, mutual funds and Exchange Traded Funds (ETFs). Of these, mutual funds and ETFs are becoming one of the most preferred or popular ways of diversifying the investments and maintain a balanced portfolio. For the uninformed, both these terms may seem to be quite identical but they are actually a very different form of investments.
Many people consider mutual funds and ETFs as identical investment funds because of the various similarities, which are as follows:
- Both of them offer a basket of any securities or investments pooled together.
- Both of them are managed by professional fund managers.
- Both of them help in minimizing the investment risks because a single fund can hold various bonds, shares, and other prominent investment instruments.
In spite of the similarities, there is also some vital point of differences between mutual funds and ETFs that you must know before making an investment.
What is a Mutual Fund?
A mutual fund is essentially a professionally managed investment fund. Here, the funds of the investors are pooled, which are then invested or diversified in various securities like:
- Government securities
- Debt securities
- Corporate bonds
- Money market instruments
An investor gets units according to the percentage of the amount invested in a mutual fund. The value of a fund is measured by its Net Asset Value (NAV). It is basically the value at which an investor can purchase or sell the funds and it is calculated at the end of a trading day. The funds are managed by the professional fund managers which are required for any investment.
It is important to note that the profits and losses in the mutual funds largely depend upon stock market performance. Some days the market may be high and some days they may crash or open lower. That’s why the mutual funds come with a disclaimer:
Mutual fund investments are subject to market risks. Please read the offer document, carefully before investing. Hence, you must always plan to invest in mutual funds, if you can take some risks. The funds are also highly liquid, which means that you can withdraw the amount any time. However, it is advisable to develop a disciplined investing, mainly for the long-term to meet your financial goals.
What is an Exchange Traded Fund (ETF)?
An ETF is basically an investment fund which is traded in the stock exchange. You can purchase and sell the ETF shares just like the stocks. As they are traded in an exchange, so their value fluctuates throughout the trading hours. These can also be transferred or sold just like any other stock. You are required to pay a commission to buy the ETF shares. It does not have Net Asset Value (NAV) like the mutual funds. The fee of an ETF is lower and has higher liquidity when compared with the mutual funds. The shareholders of ETF get the part of the profits and also receive a proportional residual value in case the fund is liquidated. The various benefits of investing in an ETF are as follows:
- It can be purchased or sold anytime during the normal working hours of an exchange.
- It is transparent as the portfolio is disclosed in public or updated on online platforms on regular basis.
- Due to the low turnover of the ETFs, they are tax efficient. This is because, when the turnover is low, then the taxable capital gains distribution will be eventually minimized.
Mutual Fund vs ETF – Which is Better?
Many experts recommend investing in mutual funds or ETFs, but the main question n pops out here which one is better for you? So, to avoid any confusion, let us look at the difference between the mutual fund and ETF:
Trading: The Net Asset Value (NAV) of a fund is calculated every day once the market is closed. So, if you want to buy or sell a mutual fund, then its NAV must be taken into consideration. ETFs are traded on the major stock exchanges throughout the day, thus the share prices tend to fluctuate.
- Performance objective: Mutual funds attempt to beat the benchmark, whereas an ETF attempts to match the benchmark.
- Tax efficient: When a mutual fund is redeemed, then it may attract some taxes. On the other hand, due to the low turnover, ETFs does not attract any taxes.
- Transparency: The list of holdings in case of the mutual funds is published on a quarterly basis. In the case of the ETFs, the list of holdings is published once per day.
- Minimum investment: Generally, there is a minimum amount required to be invested in the case of mutual funds. On the other hand, single shares in an ETF can be purchased and the prices will fluctuate throughout the trading day.
- Brokerage account: Mutual fund investments do not require any brokerage account. For the ETF investors, a brokerage account is a necessity.
- Automatic transactions: The transactions for the mutual fund investment can be set automatically. This facility is not available for the ETFs.
Selecting an investment i.e. mutual fund or ETF generally depends on your financial goals and personal preference. It is important that you must weigh the pros and cons of both the investment before you plan to invest your hard-earned money. Remember that both the mutual funds and ETFs are known to help the investors achieve their investment objectives. You may consider adding both of them in your investment portfolio as this will minimize risk and help you chase your dreams effectively.
Note: All information & data provided in this article is for the educational purpose as well as to give general information on the finance & economy, not to provide any professional advice or service. Views & opinions are not biased against the company and do not affect any official policy or any other agency, an organization within the content.