Mutual Funds vs. ETFs: Understanding the Key Differences

What are Mutual Funds?

A mutual fund is a professionally managed investment pool that combines the money of many investors. The fund manager invests the pooled money in a variety of assets, such as stocks, bonds, and cash equivalents. The value of a mutual fund share fluctuates based on the performance of the underlying assets in its portfolio.

How Mutual Funds Work

Investors engage in mutual fund pledging by buying shares of a mutual fund at a net asset value (NAV). NAV is determined by dividing the total value of the fund’s assets by the number of shares outstanding. This NAV is generally calculated at the end of each trading day.

Mutual fund pledging allows an investor can take out a loan using their existing units as collateral. These units can be pledged to secure loans from lenders, including banks and non-banking financial companies, allowing the investor to borrow money based on the value of their owned units.

Mutual funds can be either actively managed or index-based (which are passively managed), though the majority are actively managed. In active mutual funds, professional fund managers oversee and make investment decisions for the fund.

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What are ETFs?

An exchange-traded fund (ETF) is a basket of securities that trade on a stock exchange like shares.. ETFs can track a variety of underlying assets, including stocks, bonds, commodities, and even other ETFs. 

How ETFs Work

Investors buy and sell ETF shares on a stock exchange throughout the trading day, just like they would with individual stocks. The price of an ETF share fluctuates based on its  supply and demand  in the market, which may differ slightly from the NAV of the underlying assets.

List of top Mutual Funds on NSE, which gave more than 20% return in the last three years:

Fund Name	Asset Size (In Crores as of 23-08-24)	3 Yr CAGR  (in %)
HDFC Mid-Cap Opportunities Fund	₹75,382	32.02
HDFC Balanced Advantage Fund	₹89,903	26.38
SBI Contra Fund	₹37,845	31.89
Nippon India Small-Cap Fund	₹56,468	35.40
ICICI Blue Chip Fund	₹59,364	22.08
Kotak Emerging Equity Fund	₹49,023	27.32
ICICI Pru Value Discovery Fund	₹45,470	27.97
Nippon India Multi-Cap Fund	₹34,943	32.30
HDFC Small Cap Fund	₹33,181	29.05
Axis Mid-Cap Fund	₹30,854	21.76

Source: Moneycontrol

List of top ETFs which gave more than 20% return in the last three years:

Fund Name	Asset Size (In Crores as of 23-08-24)	3 Yr CAGR  (in %)
CPSE Exchange Traded Fund	₹46,793	59.75
SBI ETF- Nifty Next 50	₹3,020	24.51
Nippon ETF Junior	₹5,274	24.46
Motilal Oswal Midcap 100	₹509	30.15
Kotak PSU Bank ETF	₹1403	47.23
Nippon ETF Infra	₹203	27.2
Nippon ETF PSU Bank	₹2585	47.28
ICICI Pru Mid-cap Select	₹68	24.03
Kotak NV 20	₹73	20.41
Nippon ETF Dividend Opportunities	₹63	26.74

Source: Moneycontrol

Similarities Between ETFs and Mutual Funds

• Pooled Investment: Both represent a pool of money from multiple investors, which is then invested in a variety of securities.
• Diversification: Both offer diversification benefits by spreading investments across multiple assets, reducing risk.
• Professional Management: Both are managed by professional fund managers who make investment decisions on behalf of investors.
• Variety of Options: Both are available in a wide range of options, catering to different investment objectives and risk tolerances (equity, debt, hybrid, index, etc.).
• Investment Goals: Both can be used to achieve various investment goals, such as capital appreciation, income generation, or wealth preservation.
• Regulatory Oversight: Both are subject to regulatory oversight to protect investor interests.

ETFs vs. Mutual Funds: Key Differences

Here’s a table outlining the key differences between ETFs vs mutual funds:

Management	Actively Managed	Passively Managed
Trading	Can only be bought or sold at the end of the trading day	Can be traded throughout the trading day like a stock
Expense Ratios	Generally higher expense ratios due to active management fees	Generally lower expense ratios due to passive management
Transparency	Portfolio holdings are disclosed quarterly	Portfolio holdings are disclosed daily
Minimum Investment	May have minimum investment amounts	Typically lower minimum investment amountsExport to Sheets
Taxation	Mutual Funds are less tax efficient. To manage shareholder withdrawals or reallocate assets, a fund manager frequently sells securities. This can create capital gains for shareholders, even if some are experiencing a loss on their overall investment.	ETFs are more tax-efficient due to their lower capital gains taxes. The ETF manager deals with investments by creating or redeeming “creation units,” which are baskets of assets that represent the ETF’s total exposure. This method helps protect investors from capital gains on individual securities within the ETF.

Choosing Between ETFs vs Mutual Funds 

The best choice for you will depend on your individual investment goals and risk tolerance. Here are some factors to consider while comparing between ETFs vs mutual funds:

• Investment goals: If you are looking for an actively managed fund that has the potential to outperform the market, a mutual fund may be a good option. If you are looking for a low-cost, diversified investment that tracks a specific index, an ETF may be a better choice.
• Risk tolerance: Actively managed mutual funds can be more volatile than passively managed ETFs. If you have a lower risk tolerance, you may prefer the stability of an ETF.
• Investment time horizon: If you have a long-term investment horizon, you can afford to take on more risk. If you have a shorter investment horizon, you may want to choose a less volatile investment, such as an ETF.
• Investment amount: Some mutual funds have minimum investment amounts. ETFs typically have lower minimum investment amounts, making them more accessible to smaller investors.

Types of ETFs and Mutual Funds

ETFs and mutual funds come in various types, each catering to different investment objectives and risk tolerances. Understanding these types and knowing the differences between ETFs vs mutual funds  is crucial for making informed investment decisions.

Types of ETFs

ETFs are primarily classified based on the underlying assets they track:

ETF	Description
Index ETFs	These track a specific market index, such as the S&P 500 or Nasdaq 100. They offer broad market exposure and are passively managed, resulting in lower expense ratios.
Thematic ETFs	These invest in companies within a specific theme or sector, like technology, healthcare, or renewable energy. They offer targeted exposure to specific industries or trends.
Bond ETFs	These invest in various bonds, including government, corporate, and municipal bonds. They provide exposure to the bond market and offer income generation potential.
Commodity ETFs	These track the prices of commodities like gold, oil, or agricultural products. They can be used to diversify portfolios and hedge against inflation.
Currency ETFs	These track the exchange rates of different currencies. They can be used to speculate on currency movements or hedge currency risk.
Leveraged and Inverse ETFs	These investments use financial contracts called derivatives to achieve either higher returns or returns that move in the opposite direction of the underlying index. For example, some might aim to double the gains of an index, while others might try to profit from the index falling. Because of this approach, they are very risky and involve a high level of speculation.
Actively Managed ETFs	While most ETFs are managed passively, some are managed by fund managers aiming to outperform the market. However, they generally have higher expense ratios.

Types of Mutual Funds

Mutual funds are primarily classified based on their investment objectives and underlying asset allocation:

Equity Funds	These primarily invest in stocks and aim for capital appreciation. They can be further categorized based on market capitalization (large-cap, mid-cap, small-cap), investment style (growth, value, blend), and geographic focus (domestic, international, global)
Debt Funds	These primarily invest in bonds and other debt instruments, providing income and capital appreciation. They can be categorized based on maturity (short-term, medium-term, long-term), credit quality (government, corporate, high-yield), and interest rate sensitivity (duration).
Hybrid Funds	These invest in a combination of stocks and bonds, offering a balance of growth and income potential.
Index Funds	These track a specific market index, similar to index ETFs, but are actively managed. They offer broad market exposure at a relatively low cost.
Money Market Funds	These invest in highly liquid and low-risk securities, providing stability and liquidity.

Other classifications:

• Open-ended Funds: There is no limit to the number of shares, and investors can buy or redeem shares at the net asset value (NAV).
• Closed-ended Funds: A fixed number of shares are issued, and shares are traded on the stock exchange.
• Interval Funds: A hybrid of open-ended and closed-ended funds, where investors can buy and redeem shares at specific intervals.

Essentially, both ETFs and mutual funds provide a way for investors to participate in the market without having to invest in individual securities. The primary differences between them lie in how they are traded, managed, and structured. Now, we know the differences between ETFs vs mutual funds,  let’s understand  about their similarities, too. 

Advantages of ETF vs Mutual Fund in India

When considering ETF vs mutual fund tax benefits, ETFs often offer advantages due to their tax efficiency. ETFs usually create fewer taxable capital gains than mutual funds because they use a process called “in-kind” redemption, which helps reduce taxable events. This can result in lower tax bills for investors.

Here’s a breakdown of advantages of investing in ETFs vs Mutual Funds:

• Traded like stocks: ETFs buy and sell throughout the day on exchanges, offering more flexibility and potentially tighter prices.
• Tax efficiency: Structure often leads to fewer capital gains distributions for investors, reducing tax burden.
• Transparency: Prices constantly update, reflecting real-time value.
• Lower costs: Often have lower expense ratios compared to actively managed mutual funds.

Conclusion

Both mutual funds and ETFs can be valuable tools for investors, each offering unique benefits. When considering these options, it’s important to understand how they fit into broader securities advisory and equity asset management strategies. 

By  understanding these key differences on ETFs vs mutual funds and how they align with your securities advisory needs and equity asset management goals, you can make a more informed decision on the investment option that best suits your financial objectives.

*Disclaimer Note: The securities quoted, if any, are for illustration only and are not recommendatory. This article is for education purposes only and shall not be considered as recommendation or investment advice by Research & Ranking. We will not be liable for any losses that may occur. Investment in securities market are subject to market risks. Read all the related documents carefully before investing. Registration granted by SEBI, membership of BASL, and certification from NISM in no way guarantee the performance of the intermediary or provide any assurance of returns to investors.

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