When it comes to investing, there are more choices than ever before. While stocks and bonds used to be the go-to option for most people’s investments, exchange traded funds (ETFs) and mutual funds have revolutionised the way people think about portfolio diversification to meet both short-term needs and long-term goals. ETFs and mutual funds might share many similarities, but they also have differences that are worth looking into if you are trying to decide on an investment strategy for your financial journey.
Let’s break down what these two investment options have to offer, including features, benefits, and associated risks, so that you can form an informed investment decision.
- Liquidity and trading convenience
An exchange-traded fund trades on a stock exchange like a regular stock, and its traded price fluctuates throughout the day. This also means that you can buy or sell an ETF any time the market is open during trading hours. Mutual fund orders are executed once per day at the closing net asset value.
- Potential price of uncertainty
You can obtain the real-time pricing details (or close to real-time) of most ETFs by checking out financial websites or calling a broker. With a mutual fund, the price at which you buy or redeem depends on its net asset value (NAV) – it can often be many hours after a trade order has been placed. For example, when you place a purchase order for mutual fund units after 3 p.m., the NAV at the end of the next trading day is considered.
Note that there are different cut-off timings for equity, liquid, and debt funds.
- Diversification and risk management
Both ETFs and mutual funds offer opportunities for diversifying your portfolio, i.e., spreading out your investments among different asset classes, which reduces risk by lowering exposure to any particular sector or asset class in a portfolio. However, how much diversification depends on which type of investment vehicle you choose. For example, some ETFs contain a few stocks, while some index mutual funds, such as the Nifty 100 Index Fund, hold diversified 100 stocks representing different sectors and industries.
- Fees and expenses
Actively managed mutual funds typically have higher fees than ETFs because fund managers make all the investment decisions actively. Such management requires additional resources and skill sets that come at an added cost to investors. On an average, ETFs typically have lower expense ratios than mutual funds because the majority of ETFs are passively managed and track indices – which leads to lower costs for investors.
- Lock-in period
ETFs offer greater flexibility to investors, allowing them to buy and sell units in the time that suits their goals. Generally, ETFs are not subject to any lock-in period, and you can access your investments at any time. For closed-end mutual funds and equity linked savings schemes (ELSS), there is usually a lock-in period that must be adhered to, where premature withdrawal of the units may attract a penalty.
So, which one to choose between ETFs and mutual funds?
Ultimately, whether ETFs or mutual funds are more preferable depends significantly on the following factors –
- Type of management – passive and active style
- Your risk tolerance
- Your investment horizon
- The tax savings strategy
- Liquidity of your investments
- Expense ratio you can afford
- Your financial goals
After considering these elements, watch the markets closely and choose your investment accordingly. If both options suit your needs and interests, you can even include each and create a balanced investment portfolio that maximises diversification.