Now a lot of new investors are left confused between mutual funds and exchange traded funds. It is understandable that some people are unable to understand the similarities as well as the differences between the two. Both mutual funds and exchange traded funds have been available for investment for a long time now. Both mutual funds and ETFs invest in a diversified portfolio of asset classes and offer investors an opportunity to earn capital appreciation. However, the difference lies in the way these two funds are managed and also the investment strategy that these two funds adopt.
For those who are still confused, all ETFs are mutual funds but not all mutual funds are ETFs. ETFs are a type of mutual fund that is similar and different in several ways. While you can invest in a mutual fund scheme through a normal mutual fund account, you need a demat account to hold your ETF units. Without a demat account you cannot trade with ETF units. Apart from this, there are much more similarities and differences between these two investment avenues which we are going to discuss in this article.
A mutual fund is a pool of financial resources accumulated through investors sharing a common investment objective and invested across a diversified portfolio of securities and money market instruments. Mutual funds have minimum investment amount and investors cannot invest with an amount lower than the one mentioned in the mutual fund Scheme Information Document (SID). They are a basket of securities which are collated by the fund manager after discussing the current market trends with his team of analysts and market researchers. These designated fund managers offer active risk management and are also responsible for ensuring that they frequently traded the underlying securities of a mutual fund to earn profits.
Exchange traded funds
Exchange traded funds may invest in the underlying securities of a specific index, asset class, commodity, currency, sector, industry etc. While mutual funds may invest across market cap and money market instruments, ETFs invest in a basket of securities that are specific to its underlying benchmark. For example, a gold ETF will invest in gold bullion, gold reserves and its performance its correlated to the fluctuation in the prices of international gold. A real estate ETF will only invest in companies and securities related to the real estate market.
What are some of the similarities between ETFs and mutual funds?
Both ETFs and mutual funds aim at generating risk adjusted returns. They both invest in a diversified portfolio of securities to generate long term capital appreciation. Both ETFs and mutual funds are owned by Asset Management Companies and available for all type of investors. ETFs and mutual funds carry some kind of investment risk and it is hard to determine which one is riskier than the two. Both these market linked schemes can invest in stocks, bonds, commodities depending on the fund manager and the investment objective of the scheme. Both mutual funds and ETFs can be highly volatile over the short term and are usually preferred by investors with a long term investment horizon.
Differences between ETFs and mutual funds
Investors can control their ETF investment portfolio, but they cannot control the underlying portfolio of a mutual fund scheme. To invest in ETFs investors, need a demat account whereas one can invest in mutual funds without a demat account. ETF units can be live traded at the stock exchange, but investors can only buy or sell mutual fund units determined by the NAV concluded at the end of the day. Mutual funds are actively managed and have a high expense ratio but since ETFs offer passive fund management their management fees are relatively lower.