ETF vs Mutual Fund: Key Differences for Investors

Exchange-traded funds and mutual funds are both pooled investment vehicles. They use it to buy shares, bonds, golds or other assets. But they operate in different ways. The gap is useful to know, as it allows an investor to connect a product to a goal. Time, access to cash, cost and risk also matter. This guide explains the difference between ETF funds and mutual fund schemes.

What is an ETF fund?

ETF funds are schemes that are listed on a stock exchange. Most follow an index such as the Sensex or Nifty 50. Others follow sectors, global markets, bonds or gold.

ETF units are traded during market hours, like shares. Their price can go up and down during the day. It may be affected by demand, supply and values of fund assets. An investor generally needs a trading account and a demat account.

What Is a Mutual Fund? 

A mutual fund is a pool of money from many investors. The fund manager invests the pool as set out in the scheme document. The scheme can use an active plan. It might also have a passive index strategy.

The units are purchased from or redeemed back to the fund house. Orders are placed at the relevant net asset value (NAV). Cut-off rules specify which NAV applies. 

Differences between ETF Funds and Mutual Funds

1. Trading Process

The ETF units are traded at an exchange. A mutual fund deal is done by a fund house. You can use its app, web site, registrar, or approved distributor.

2. Expense

During market hours, an ETF has a live price. It can be traded around its NAV. It can also trade above or below it.

The NAV associated with a mutual fund order is declared after the market closes.

3. Account Requirements

ETF investing usually involves opening demat and trading accounts. Mutual funds can be held without a demat account. Investors can access through a fund house website, app, registrar or distributor.

4. Style of Fund

A large number of ETFs are passive. They are looking to copy an index or asset. They do not depend on active security calls.

Mutual funds can either be active or passive. In an active scheme, the fund manager picks assets. The choices have to be in the stated mandate. An indexed mutual fund tracks an index.

5. Cost

The costs of an ETF may include the expense ratio and broking. Exchange fees, taxes and the bid-ask spread may also apply. ETFs with low trading volumes can have large spreads.

The cost of a mutual fund includes the expense ratio. Some schemes may charge exit load. It may apply when units are sold within a specified period. Straight and recurring plans have different cost structures.

6. The Investment Process

ETF units are bought in whole units at the market price. The investor makes an order. The unit count and order type must be chosen.

Let’s say a mutual fund gets Rs.100. This promotes fixed sums through a systematic investment plan or a SIP. Some brokers have set ETF buys. How this is done depends on the platform.

7. Liquidity

ETF liquidity depends on the trading volume and market makers. Spreads and fund assets are also important. Low-volume ETF may not trade at the expected price.

The redemption of open-ended mutual fund units is done through the fund house. Scheme rules apply. The timing of payment depends on the asset type and current rules.

8. Control and Comfort

ETFs can be ordered intraday with limit prices. They also enable real-time control. This might be suitable for investors who know exchange orders and spreads.

Mutual funds are an easy way to invest toward a goal. They also promote regular investment. An investor need not keep track of the live prices throughout the day.

A Simple Illustration

Suppose an investor wants exposure to the Nifty 50. One of the options is a nifty 50 ETF. The investor will buy units on the exchange. The quoted market price is valid.

You can also look at a Nifty 50 index mutual fund. The investor enters an amount, say 5,000. Units are then issued at the NAV applicable at the time of issue. They both may track the same index. But the buying route and price process are not the same thing.

How to Pick

• Begin with the goal. Think about the time frame and risk tolerance. Consider the need for cash access as well.
• Next, check whether live exchange trade is useful. For an ETF look at volume, spread, tracking error and Expense Ratio.
• In case of mutual funds, verify the scheme type. Look at the direct or regular plan. Also check the expense ratio, exit load, portfolio and risk label.
• Compare total cost. Don't just look at the expense ratio. 

Before investing, please read the scheme document. Tax laws can change. Get a qualified tax adviser or check current rules.

Conclusion

ETFs and mutual funds are both useful ways to invest in a group of assets without having to buy each investment separately. However, they work differently. ETFs are traded on stock exchanges during market hours, so their prices can change throughout the day. Mutual funds are bought and sold based on the applicable NAV and do not usually require a demat account.

The choice between an ETF and a mutual fund should depend on your investment goal, time period, risk level, cost, and how easily you want to buy or sell the investment. ETFs may suit investors who are comfortable using a trading and demat account and want the flexibility of live market prices. Mutual funds may be more convenient for investors who prefer a simpler investment process and regular investing options.

It is also important to understand that both options carry market risk, and returns are not guaranteed. Before investing, check the fund's objective, costs, portfolio, and risk level. Instead of choosing only based on past returns, consider whether the investment fits your overall financial plan. Understanding how each option works can help you make a more informed choice and stay focused on your long-term goals.