How are ETFs different from mutual funds?

Exchange-traded funds (ETFs) and mutual funds are popular investment instruments that seem similar. They’re less volatile than stocks and can help create long-term wealth. However, the two have significant differences, and you should know about them before investing. This article walks you through exchange-traded funds and mutual funds and how they differ.

What is an exchange-traded fund?

An exchange-traded fund is a basket of securities investors can trade, just like a company's share. ETFs are popular and valuable because they're offered in all asset classes, including commodities and currencies. An ETF's price changes daily as it is traded live on stock exchanges. They're also of several types, with a few of them listed below:

Equity ETF

Equity ETFs track indices like the NIFTY 50. The price of an equity ETF is determined by its underlying index’s movement, which is why it keeps changing daily.

Bond ETF

Bond ETFs are a combination of debt instruments. They track fixed income instruments such as debentures and government bonds.

Thematic ETF

Thematic exchange-traded funds track the performance of a particular industry. They are also called 'Sectoral ETFs' since they replicate the performance of a particular sector.

Commodity ETF

Commodity ETFs are among the most popular ETFs in India. Gold ETFs and silver ETFs are the two commodity ETFs available in India.

International ETF

If an investor wishes to invest in foreign companies directly, they can invest in international ETFs. An international ETF tracks the index of a specific country or region.

What are mutual funds?

A mutual fund is a pooled investment that collects money from various investors and invests it in securities like stocks, bonds, and other assets. Depending on the criteria of classification, mutual funds can be divided into many types.

Open-ended mutual fund

A mutual fund scheme that is available for subscription and redemption throughout the year is called an open-ended mutual fund.

Close-ended mutual fund

In a close-ended mutual fund, the mutual fund units can only be purchased during the initial offer period. These units can later be redeemed at the maturity date.

Actively managed mutual fund

An actively managed mutual fund is managed by a fund manager who decides which stocks to buy, sell, or hold. These decisions are based on the fund manager's professional judgment and are backed by analytical research.

Passively managed mutual funds

These mutual funds aren't managed by a fund manager. A passively managed mutual fund track's the scheme's benchmark index.

Based on asset class, mutual funds are further divided into four major types.

Equity mutual fund

Equity mutual funds invest in stocks. The risk and reward in equity mutual funds are high.

Debt mutual fund

Debt mutual funds invest in debentures, bonds, and other fixed income assets. They’re comparatively safer than equity mutual funds.

Money market mutual fund

Money market mutual fund invests in liquid instruments. Investors looking to park their surplus funds in a low-risk investment instrument can invest in a money market mutual fund.

Balanced hybrid mutual fund

A balanced hybrid mutual fund invests in a mix of asset classes, maintaining a certain percentage between equity and debt. In this way, the risk and returns are balanced.

ETFs vs mutual funds: What is the difference?

ETFs and mutual funds have fundamental differences. We've listed a few of them below:

1. The value of an exchange-traded fund changes during a trading day. A mutual fund, however, is traded on the closing net asset value (NAV).
2. Exchange-traded funds can be bought and sold at any time on the stock market at the prevailing market price. In contrast, a mutual fund can only be purchased at the NAV price fixed during the trading day.
3. Mutual funds have varying operational expenses, whereas exchange-traded funds do not come with additional costs.
4. Certain mutual funds charge a penalty upon selling units early. An exchange-traded fund does not attract any charges on the sale of an asset.

ETF vs mutual fund: Where to invest?

The decision between ETFs and mutual funds depends on your investment strategy and risk appetite. Both investment vehicles offer unique benefits to help build wealth. You can invest in them consistently to achieve your investment goal. If you’re investing in mutual funds through a Systematic Investment Plan (SIP), you can use IDFC FIRST Bank’s SIP calculator. It can help you plan your investments and reach your goal faster.

Disclaimer

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