ETFs vs Funds. 3 ways they’re driven differently.
An easy way to think of investments is like they’re different vehicles. Two common choices an investor have are Exchange Traded Funds (ETFs) and Mutual Funds). At first glance, they may seem similar as they both sell a mixed basket of stocks or bonds, but they’re actually different.
Make the most of your investment journey by understanding the differences between these two investment vehicles.
How are ETFs and Mutual Funds driven differently
#1: The route taken
ETFs and Mutual Funds may both get you to your financial destination, although not necessarily by the same route.
Since ETFs invest in a variety of assets that mirror an index, they generally move in the same direction as that index. It’s like a driver flowing along with the traffic, at a similar speed. ETFs only change the weightage of their assets to meet any changes in the index it is tracking. This is known as passive management.
An ETF gives you returns close to the benchmark it tracks. For example, if the Nifty 50 Index delivers a return of 6%, an ETF which tracks it would aim to deliver similar returns. However, since indexes can sometimes change their weightage, an ETF’s returns could be affected by these changes. Its returns could be higher or lower, depending on the changes.
Depending on the asset class, ETFs can also track bond indices (such as liquid ETFs) or commodities (such as gold ETFs)
Mutual Funds, on the other hand, aims to deliver better returns than the market average. Fund managers monitor the markets full-time and rebalances the fund by buying and selling stocks to achieve their objective. They’re like drivers who keep consulting a GPS to find a more efficient route to their destination when conditions aren’t ideal. This is known as active management.
While this may help the fund get ahead, there are always risks involved. The fund manager could make a decision that doesn’t pay off.
#2: Fees and Expenses
Since ETFs are passively managed, you pay lower fees in the long run. Mutual Funds, however, involve active management, which is like having a full-time driver manging the vehicle. The cost covers the resources required to manage the fund – fund managers operating on a full-time basis and maintaining an in-house research team to conduct on-the-ground visits with portfolio companies.
#3: Lock in period
There is no lock-in period for an ETF. Depending on the scheme type, some Mutual Funds can have a lock-in period. For example, an equity-linked savings scheme (ELSS) comes with a lock-in period of 3 years
There’s no right or wrong choice. The type of Fund or ETF you choose depends on your financial needs and goals, as well as risk profile and investment horizon.
Another point to note is that you need a demat and trading account to invest in ETFs in India. If you are not comfortable with operating these accounts, ETFs may not be the right choice for you.
Disclaimers and Important Notices
This article is meant for information only and should not be relied upon as financial advice. Before making any decision to buy, sell or hold any investment or insurance product, you should seek advice from a financial adviser regarding its suitability.
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Read up more on Mutual Funds here
Mutual Fund investments are subject to market risks, read all scheme related documents carefully before investing.