If you’ve recently started exploring investments, chances are you’ve come across both ETFs and mutual funds. For a while, they might look quite similar since you gain exposure to a basket of assets through both. However, you start getting the differences once you dig a little deeper.
Your investment experience can be influenced by the way they are managed, purchased, or used in a portfolio. That’s why we have explained how ETFs differ from mutual funds, so that you can choose the investment option that complements your goals.
What is an ETF?
An ETF, or exchange-traded fund, is an investment that you can trade on the stock exchange, similar to shares of companies. If you’re wondering what is ETF, it’s a fund that tracks an index, sector, or commodity. Investors can purchase it like stocks in one go. The price of an ETF keeps changing throughout the trading session, based on demand and supply in the market.
Most ETFs follow a passive strategy. They tend to mirror the performance of an index, and don’t try to beat it.
Investors who want flexibility and look for the option to buy or sell the funds during market hours often find ETFs a suitable option.
What are mutual funds?
The money you invest in a mutual fund is allocated across a wide range of assets like equities, bonds, and sometimes, a mix of both. Usually, professional fund managers are entrusted to manage these assets. Based on the objective of the fund, they make the investment decisions. While some mutual funds try to outperform the market, others track an index.
Transactions in mutual funds take place at the end of the day, based on the NAV. This makes them simple and convenient, particularly for investors looking for a steady and long-term approach through SIPs.
Key differences between ETFs and mutual funds
Before you choose any of these, it pays to know the difference between ETF and mutual funds.
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Trading and liquidity
The way these investments are bought and sold defines one of the most noticeable differences. ETFs trade on stock exchanges. Therefore, you can buy or sell them anytime during market hours at the current price. As a result, investors enjoy more control and flexibility.
However, mutual funds are processed at the end of the day, which doesn’t give you real-time pricing. The process, however, is simpler and does not depend on market timing.
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Cost and expense ratio
With ETFs, the expense ratios are generally lower as they follow a passive approach to investment and do not require active management. Over time, they turn out to be cost-effective.
On the contrary, mutual funds, particularly the actively managed ones, usually have higher costs. This is due to the research and fund management efforts involved in the process.
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Flexibility and investment style
Investors who prefer flexibility and can make decisions during market hours may consider ETFs. On the other hand, mutual funds are suitable for those looking for a consistent approach through SIPs.
Which one should you choose?
While deciding whether to invest in an ETF or a mutual fund, consider your investment style and convenience.
Based on investment style
If you are in a position to actively track the market and make timely decisions, ETFs might feel more suitable. However, if you don’t want to worry about daily price movements and need a simpler approach, mutual funds can be a better fit.
Based on convenience and goals
Consider your financial goals and comfort level, too. Those looking to create long-term wealth through SIPs often choose mutual funds. ETFs, on the other hand, can be suitable for those looking for flexibility and lower costs.
Conclusion
Both ETFs and mutual funds can be effective options for investment, and each comes with its own advantages. As an investor, you must consider how well the investment aligns with your financial goals and how consistently you can stick with it.
Once you decide on the strategy, check out the best-performing ETFs and mutual funds under the category that suits your risk tolerance. With a thoughtful approach, you can build a strategy that works for you over the longer horizon.
