When investing your hard-earned money, your financial planner would likely suggest exchange-traded funds and mutual funds as choices. Mutual funds and exchange-traded funds have a lot of similarities, which might easily confuse a potential investor. They are, nonetheless, distinguished by a few vital differences.
When choosing between the two, many investors have no choice. ETFs and mutual funds both invest in a number of assets and are a typical way for investors to diversify their portfolios. You can combine the two and effectively use them to develop an investment portfolio based on your financial goals and investment period.
What are mutual funds?
Unlike ETFs, mutual funds cannot be traded on any day. They’re only bought at the determined price at the end of the trading day. They’re also regularly done by a professional fund manager who works with a team of researchers to diversify your investments by investing in various money-making products. Mutual funds are nothing more than a pool of assets made by various participants with a common goal.
What Are Exchange-Traded Funds?
Exchange-traded funds are a type of mutual fund. They assist individual investors in gaining a broad understanding of the investment alternatives available to them. These are stock exchange-listed, passively managed index funds that hold all the companies or shares that have the same asset value as the underlying index, and ETFs could be sold and bought in real-time at a price that fluctuates during the day.
Differences between Mutual Funds and ETFs
One of the most difficult decisions an investor faces when investing is deciding between a mutual fund and an exchange-traded fund (ETF). Even though both of these products appear to be very similar, some variances exist between them. The following are the key distinctions between mutual funds and ETFs.
Flexibility: ETFs are freely traded on the market and can be purchased and sold to suit the investor’s needs. Like conventional stock shares, their market price is visible in real-time. Units in mutual funds can only be acquired or sold by submitting a request to the fund house. The NAV is the price of one mutual fund unit.
Expenses and Fees: ETFs do not require active management because they simply mirror the market index. As a result, the costs and expenses of investing in ETFs are minimal. On the other hand, Mutual Funds have a fund manager that actively makes financial decisions on behalf of investors. As a result, fund administration costs have increased.
Commissions: Because ETFs are traded on the exchange like any other stock, investors must pay commissions on the sale and purchase of units in accordance with the rules. However, there is no need to pay a commission for the sale and acquisition of mutual funds.
Management: Well, mutual funds are more likely to be actively managed by a seasoned fund manager who makes all investment decisions on behalf of the clients. On the other hand, the funds in ETFs simply track the market index. Actively managed ETFs are also available. However, they have a higher expense ratio.
Lock-in Period: When it comes to ETFs, there is no minimum holding period and investors can sell the investment whenever they want. The lock-in period for mutual funds like ELSS (Equity Linked Savings Scheme) is three years. It is not feasible to liquidate the investment within this period. Depending on the mutual fund plan chosen, this can vary from 9 days to 3 years.
How can you decide between ETFs and mutual funds?
Both Mutual funds and ETFs are ideal for diversifying your financial portfolio. There are numerous aspects to consider while deciding which choice to choose.
- Liquidation of the investment is simple
- Your willingness to take risks
- Your time frame for investing
- You’ve devised a tax-saving approach
- Your financial objectives
After you’ve answered these questions, you’ll be able to narrow down which of the two options is the best fit for you. ETFs provide more flexibility and higher short-term returns, but mutual funds allow you to stay invested for a longer time and help you build a future corpus. The choice must be solely yours, but it must be made after much thought.