What is an ETF?
Exchange Traded Funds, or ETFs, are investments that hold a basket of securities and trade on a stock exchange. Many ETFs are designed to follow an index such as the Nifty 50 or Sensex, or assets like gold. So, instead of buying all the companies in a particular index, you can buy one unit of an ETF that gives you exposure to that basket.
If you compare a mutual fund vs ETF, you may think they operate in a very similar way. They both give you diversification through a single investment. But the way you buy and sell them is different.
You need a demat and trading account to buy an ETF. But you can invest in a mutual fund through a platform like Millions or directly with the fund house. You don’t need a trading account or demat account for a normal mutual fund investment.
What are the benefits of investing in ETFs?
There are several things that can make ETFs attractive for investing, such as:
- Lower expense ratio: ETFs follow an index rather than having a fund manager actively pick investments. This keeps their expense ratio lower than actively managed mutual funds.
- Tradable during market hours: ETF units can be traded like shares. You can place an order during market hours and trade at the available market price.
- Easy diversification: One ETF can give you exposure to many stocks or other assets. You don’t have to buy every stock separately.
- Live market price: ETFs have live prices that move throughout the day when the market is open, unlike mutual funds, where NAV is computed based on the closing price.
- Useful for index investing: If you want to invest in a particular index, like Nifty Bank, for example, then an ETF can be a simple way to do it without buying each company's stock yourself.
What are the drawbacks of ETFs?
Investing in ETFs comes with its own set of downsides too, such as:
- You need a demat and trading account: This adds another step to starting your investment journey compared to investing in a mutual fund through simple platforms like Millions.
- Prices fluctuate throughout the day: This can sound like an advantage, but it can also tempt you to keep checking prices and making short-term decisions.
- Trading costs can add up: ETFs may have a brokerage, bid-ask spread, and other trading-related costs. So, don’t compare only the expense ratio. Look at the overall cost.
- Not every ETF is heavily traded: An ETF with low trading volume may be harder to buy or sell at the price you want. In such cases, the market price can also move away from the underlying value.
So, in the mutual fund vs ETF comparison, lower cost doesn’t mean a better investment. Even while investing in ETFs, you are taking the market risk.
Mutual fund vs ETF: What’s the difference?
Both the options help you build a diversified portfolio, but the experience is quite different:
Mutual fund vs ETF: Which one to choose?
Here’s a list of a few things you should be clear about while making a choice:
- How you want to invest: If you want to automate your investment without manually buying the units, a mutual fund may be better. ETFs work through the stock market, so you normally need to place trades yourself.
- What you want to invest in: If you want an actively managed equity fund, debt fund, or hybrid fund, then mutual funds give you more options. ETFs typically track an index or focus on specific asset classes such as gold or silver.
- How often you plan to invest: If you are investing a fixed amount every month, you may find mutual funds more convenient. You can also choose a smaller frequency, such as daily or weekly SIP payments.
- How much flexibility you need: If you want to buy or sell during market hours at a live market price, then an ETF may suit you better. Mutual funds are operated based on NAVs, which are calculated using the closing price at the end of the day.
The bottom line
The mutual fund vs ETF comparison becomes important because both give you similar market exposure but offer a very different investing experience. If you are a beginner who wants to invest regularly without dealing with a trading screen, then you may find mutual funds an easier option. Once you get comfortable with demat accounts, market orders, and exchange trading, you can explore ETFs.
In reality, both options offer you diversified investment choices. So, start with what you understand and invest a small amount to begin. As you gain experience, you can gradually increase your investments across different assets.
