ETF vs Mutual Fund: Differences, Returns, and Costs

Investing is an important step towards building long-term wealth, but a beginner may find the choice of the investment option quite confusing. Out of the various investment options available, Exchange Traded Funds or ETFs and mutual funds are preferred by most novice investors who wish to gain exposure to markets without selecting individual stocks.

Knowing the key differences between ETF vs Mutual Fund can aid an investor in understanding the potential returns, expense ratio, and other key factors. Though ETFs and mutual funds have several similarities, as both funds combine the money of multiple investors and invest the corpus in a diversified portfolio, the two products have differences that must be taken into account before opening an investment account.

To begin with, this article will discuss in detail what an ETF and a mutual fund are. Furthermore, the article will also delve into the differences between the two funds concerning returns and expense ratios. Subsequently, the article will conclude with the ETF vs Mutual Fund for Beginners, and which investment is more suitable for a new investor.

What Is an ETF?

An Exchange Traded Fund or ETF is an investment fund that includes a collection of securities or assets, such as stocks, bonds, commodities, etc. A mutual fund company operates an ETF, which allows the investors to purchase shares in the fund, providing diversification to the investors.

For example, a Nifty 50 ETF is a fund that attempts to replicate the performance of the Nifty 50 index. As such, the performance of the Nifty 50 ETF should be similar to that of the Nifty 50 index, barring tracking errors and expense ratios.

One prominent difference between ETF vs Mutual Funds is that ETFs can be bought and sold on stock exchanges, wherein the price of ETFs may change throughout the day.

For a comparison of trading, pricing and transaction costs, see NSE’s comparison of ETFs and other mutual funds.

What Is a Mutual Fund?

You can explore mutual fund NAVs and returns on Rupix to review individual schemes. Compare funds with similar objectives and benchmarks.

A mutual fund is an investment scheme in which a fund manager invests the money of multiple investors in a portfolio comprising equities, bonds, money market instruments, and other assets, depending on the fund’s investment objective. Mutual funds can be actively or passively managed, with the former including the decisions of a fund manager and the latter including a strategy to track a benchmark index.

A mutual fund has a NAV or Net Asset Value, and investors may purchase units from a mutual fund directly or through an intermediary. A notable feature of mutual funds is that an investor may choose the Systematic Investment Plan (SIP) in a mutual fund that would allow him or her to invest a specified amount in the fund every period.

How ETF Works

How ETF Works is explained below :

An ETF is created by collecting the money from investors and allocating the corpus to a diversified portfolio, depending on the investment objective of the fund.

For example, a Nifty 50 ETF’s portfolio consists of the Nifty 50 securities, and as such, the fund’s performance tracks the Nifty 50 index, barring the fund’s expenses and tracking errors. An essential characteristic of an ETF is that it is traded on the stock exchange, and investors may buy or sell ETF shares in the same manner as shares of stocks.

The mechanism through which an ETF works is explained below :

• Investment: An investor must open a Demat and trading account and purchase shares of the ETF.
• Market Trading: During market hours, an investor may buy or sell ETF shares, depending on the demand and supply of the security.
• Pricing: Throughout the day, the price of an ETF may change, depending on the demand and supply of the security.
• Returns: An investor will earn returns in the form of the appreciation in the price of shares and any dividends, if any, paid by the fund.
• Redemption: An investor may sell the shares on the stock exchange or the authorised participants in case of large-volume transactions.

Since most ETFs are designed to track a certain index, most ETFs are passively managed and hence incur comparatively lower management expenses.

How Mutual Funds Work

How Mutual Funds Work is explained below :

Mutual funds work by collecting the money of multiple investors and managing the corpus in accordance with the investment objective of the fund.

For example, an equity mutual fund invests the corpus of the investors in a diversified portfolio of equities, while a debt mutual fund invests the corpus in debt instruments. 

The mechanism through which a mutual fund works is explained below :

• Investment: An investor must open an account with the Asset Management Company (AMC) and invest in the fund through a lump sum or a Systematic Investment Plan (SIP).
• Fund Management: The fund manager manages the corpus in accordance with the investment objective of the scheme.
• NAV and Transaction Pricing: The scheme calculates its NAV. For purchases, the applicable NAV depends on the relevant cut-off timings and when the investment funds become available to the scheme. See AMFI’s guidance on cut-off timings and applicable NAV for details.
• Returns: An investor may earn returns in the form of appreciation in the NAV of the fund and any dividends, if any, paid by the fund.
• Redemption: An investor may sell the units of the fund in accordance with the exit load and other terms and conditions of the scheme.

ETF vs Mutual Fund: Key Differences

ETF vs Mutual Fund is discussed below :

Particulars	ETF	Mutual Fund
Trading	Traded on the stock exchange	Bought and sold through the fund
Pricing	Pricing changes throughout the day	End of day price updates
Trading Account	Demat account in India	Not mandatory
Management	Passive ETFs and Active ETFs	Actively and passively managed funds
Investment	Bought and sold in units	Lump sum or SIP
Expense ratio	Passive ETF has a lower expense ratio	Lower or higher expense ratio depending upon the fund
Liquidity	Depends upon market makers	Depends upon the fund’s terms and conditions
Transparency	High	Depends upon the fund
Transaction charges	Brokerage and other applicable charges	No stock brokerage if the investor invests in the direct plan
Minimum investment	Dependent on the cost of one unit and other applicable charges	Dependent on the scheme

The choice between ETF vs Mutual Fund for Investing ultimately depends on the preference of the investor. wherein factors such as transaction charges, investment amount, and other expenses must be taken into account by the investor before making a decision. 

It must also be noted that both funds are subject to market risks and are non-guaranteed investment products, and therefore the performance of the fund cannot be predicted with certainty.

ETF vs Mutual Fund Returns

ETF vs Mutual Fund Returns are discussed below :

It must be noted that neither of the two investment options provides guaranteed returns as the returns depend on the portfolio of the fund and the performance of the asset in which the fund has been invested.

For example, the returns from a Nifty 50 ETF and a Nifty 50 Mutual Fund will depend on the performance of Nifty 50 index portfolios and the expense ratio of the funds, wherein the expense ratio reduces the returns of the investor. 

Though a mutual fund may be able to deliver higher returns than its benchmark if the fund tracks the performance of the index or actively manages the portfolio of the fund in accordance with the investment objective, an actively managed mutual fund incurs higher management expenses, which ultimately reduces the returns of the investor.

The performance of the funds depend on various factors, such as market risks and management fees, and it is difficult to predict the performance of the funds accurately.

Furthermore, it must be noted that when assessing the performance of the funds, the returns of the two funds should be compared over the same time frame, such as one-year returns, three-year returns, and five-year returns, and should be compared keeping in mind the risk profile and the benchmark of the scheme.

ETF vs Mutual Fund Expense Ratio

ETF vs Mutual Fund Expense Ratio is discussed below :

The expense ratio of a fund is the total operating expenses of the fund as a percentage of the total assets of the fund. The expense ratio is important for an investor as it can impact the returns of the investor.

The expense ratio of ETFs is generally lower than the expense ratio of mutual funds as ETFs are typically passively managed funds that track the performance of an index, and mutual funds can be actively or passively managed. 

The expense ratio of an actively managed fund is higher than a passively managed fund as an actively managed fund requires a higher degree of research, management, and other expenses on the part of the fund manager.

The expense ratio is one of the important factors when considering ETF vs Mutual Fund for Investment, but it must be evaluated alongside various other factors, such as management fees, transaction costs, and other expenses.

ETF vs Mutual Fund for Beginners

ETF vs Mutual Fund for Beginners is discussed below :

Both investment products can be suitable for a novice investor, but it ultimately depends on the preference and experience of the investor. 

A beginner should be aware of the risk associated with both funds and have a basic understanding of how each fund works before making an investment decision. 

An ETF typically incurs higher trading expenses and requires the investor to have a Demat account; however, ETFs provide flexibility to the investors as it can be bought and sold within market hours.

A mutual fund, on the other hand, is a more convenient option for an investor as beginners can start with a SIP and do not need a Demat account. However, it must be noted that an ETF can provide diversification and flexibility to the beginner investor if he or she has the requisite knowledge of the stock market.

Which Is Better: ETF or Mutual Fund?

Which Is Better: ETF or Mutual Fund is discussed below :

Both investment vehicles have their own advantages and disadvantages and can be suitable for different types of investors.

An ETF provides flexibility as it can be bought and sold within the market hours, but a mutual fund allows an investor to utilise the SIP facility and invest in the fund conveniently. An ETF generally incurs lower operating expenses, but a mutual fund can provide diversification to the investor. 

Therefore, it ultimately depends on the objective of the investor, wherein the novice investor must take into account several pertinent factors, such as investment horizon and liquidity, before making the decision.

Conclusion

The objective of this article was to discuss in detail the differences between ETF vs Mutual Fund. In brief, the article can be summarised as below :

ETFs and mutual funds enable an investor to undertake diversification in his or her investment portfolio but have several differences in terms of trading, pricing, management, expense ratio, and other factors.

An ETF provides the flexibility of trading within market hours, but it incurs higher trading charges and requires a trading account. On the other hand, a mutual fund does not require a Demat account and provides a more convenient method to buy and sell the fund. 

Though an ETF typically has a lower expense ratio, a mutual fund can provide diversification to the investor if he or she invests in an equity mutual fund that tracks the performance of a diversified portfolio of equities. Lastly, an investor must assess multiple factors when considering ETF vs Mutual Fund for Investment.

Disclaimer: This article is for educational purposes only and should not be construed as financial or investment advice. Mutual Fund and ETF investments are subject to market risks, and therefore, investors must read the scheme information prospectus before making an investment decision.

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