ETF vs Mutual Funds: Review, Difference, Performance

ETF vs Mutual Fund is one of the top question in every investor’s mind. We review the difference, performance and investment methodology of both in this blog post.

Mutual funds and ETFs are very different products but there are similarities with mutual funds. But lately, ETFs are grabbing attentions from mutual fund investors due to its many unique features like can be traded like a common stock, very low fees and other useful applications of the fund. We will discuss in details in this post about different features and factors of ETF and Mutual Funds.

Exchange Traded Funds (ETFs)

ETFs are the class of exchange-traded investment product in which investor pool money in the fund from a different class of investors. The fund invests in a particular index, commodity, bonds or some other asset class in the market. Unlike a mutual fund, ETFs are traded on the terms of common stocks. The main characteristic of ETF is that its unit is treated a unit of stock and price is determined on a  real-time basis. It tracks a particular index of its asset class

Mutual Funds

Mutual funds are the professionally managed fund which pools money from numerous small investors. The fund invests in stocks, bonds of publicly traded companies and government securities based on the objectives of the fund. There are various categories of mutual funds like equity fund, debt fund, balanced funds etc.

Comparison between ETF and Mutual Fund

How does it work

The creation of ETF units is more complex than creation of new mutual funds units. The process begins with the creation of ETF units. ETF shares are not directly sold to the public for cash. The sponsor of the Fund (Asset management company) takes shares of the companies comprising the index from different categories of investors like authorized participants, Large Institutional Investors. In return, it issues them a large block of ETF units called “creation units“. The dividend (cash component) which are given on the stocks is also taken from such investors in exchange of ETF unit. These ETF units are then listed and traded in an exchange. The outstanding ETF units are not limited. New units can be created by the same process and redeemed in exchange of ETF units to underline shares.

In mutual funds, process is much simpler than ETF. When new investments are done on any fund, new units are created by purchasing the underline shares and new units are issued to the investors and during the liquidation of investment underline stocks are sold to pay the investor.

Approach to Investment

ETFs are passively managed fund traded on an exchange as a common stock and price discovery is done in real time basis. Buying and selling of ETFs are carried throughout the trading session and fluctuations of price is affected by market conditions.

Mutual Funds are both actively and passively managed funds. The price of the fund or NAV is determined after the close of market. New investment in mutual funds is executed at a previous day’s NAV. Effect of market volatility on the fund can only be known after the close of the market,

Holding period

As ETF’s are traded on an exchange, it can be traded for intraday positions and short positions can also be executed. There is no specific holding period for ETFs. One can trade in ETFs and invest for long term period also.

Mutual Funds are designed for long term investment purpose and wealth creation in a disciplined fashion. Investment period in mutual fund depends on the financial goals of the investor and investment objective of the fund. Investment in mutual funds is available from short term to long term period. There is no lock-in period for investing in mutual funds

Transaction fees and Charges

Investing in ETF does not include any entry or exit load. The only brokerage charges are applied on the investment just like any common stocks. The expense ratio on ETF funds ranges from 0.1-0.5% which is adjusted to the price.

Investing in Mutual funds does not have any entry charges. But if the investment is liquidated within stipulated time ( most one year for equity funds) exit load is charged on the investment in the range of 0.5-1%. Expense ratio for actively managed funds are between 1.5%-2.5%

Taxation

For ETFs

ParameterIndex ETFGold ETFSectoral ETFInternational ETF
Wealth TaxNilNilNilNil
Short Term Capital Gains Tax15%As per the Income Tax Slab15%As per the Income Tax Slab
Long Term Capital Gains TaxNil10% without indexation or 20% with indexationNil10% without indexation or 20% with indexation
Securities Transaction Tax (STT)Nil0.125%Nil0.125%

For Mutual Funds Tax obligation on investment in equity funds (those fund with the equity portfolio of more than 65%) for the period of more than one year are Tax-free and for less than 1 year are taxed 15% short-term capital gains tax.

For Debt fund, investment for a period of 1-3 years are considered short term and it is taxed @ 10% and for more than 3years, it is taxed 20% with the benefit of indexation.

Minimum Investment amount

Minimum investment amount for ETF is Rs 10000. After the ETF is listed on an exchange, investors can buy or sell additional units only through the recognized stock exchange. Investment through Systematic Investment Plan (SIP) is not available for ETFs.

Investment in mutual funds is more flexible. Investors can opt for a lump sum or Systematic investment plan (SIP). Minimum investment amount required is Rs 5000 for lump sum and Rs 500 if opted for SIP which can increase at multiple of Rs 500.

Applications of investment

ETFs can be used in trading strategies and for long term investment. Here are few advantages of ETFs for the different class of traders and investors.

  • Retail investors-  It allows diversification of portfolio with one single investment. Due to low-cost design, it enhances return in the long term
  • For Institutional investors and Mutual funds it allows them easy asset allocation, hedging and efficient use of surplus cash
  • For Arbitrageurs, it provides them easy and low-cost option to carry out arbitrage between cash market and futures.

Mutual fund’s investment application is wealth creation over the long-term through equity and debt investment managed professionally. They are well suited for long term value investors

Conclusion

ParametresETFMutual Funds

ManagementETFs are passively manged. ETF tracks their index closelyMost of the mutual funds are actively managed. Only Index funds are passively manged
PricingPricing of ETF stocks are done on real time basisAfter the close of markets, NAV of the fund is declared
Fees and ChargesNo entry/exit load is charged. Only brokerage, management fees and taxes are chargedOnly Management fess is charged. Exit load is charged in case liquidation of investment before stipulated time
Trading AccountTrading account is required to buy/sell ETFsNo trading account is required
ApplicationInvesting surplus cash, Hedging, ArbitrageInvesting surplus cash

3 Comments

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  • Hello,

    What are the best ETFs to invest in India today ?

    Thanks.

    Jamir 2 days ago Reply


  • Hello,

    How do you say mutual fund are better. ETF is best. I have many ETFs and they give good interest.

    Rajamudhry 2 weeks ago Reply


    • Hello Raj

      Can you please share some of the ETFs you hold,and I will be able to prove that carefully chosen mutual fund portfolios outperform ETFs in India

      Cheers…sarab

      Sarabdeep Singh 2 weeks ago Reply


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