Mutual funds vs ETF
Mutual funds and ETFs are different but similar investment vehicles with their pros and cons. The main objective of investing in these funds is to have an easy way to diversify.
Mutual funds came way before ETFs, and the first mutual fund was created in 1963 in India. Mutual funds are an investment vehicle that includes stocks, bonds, or maybe other assets. These mutual funds are created by multiple investors pooling their money together to then invest in these assets.
Mutual funds are operated by fund managers who invest the fund’s capital to produce profit for investors. The main thing with mutual funds is that it gives the average investor access to professionally managed funds.
ETFs or Exchange Traded Funds launched in 2002. It started slowly to grow, but recently it became one of the fastest-growing investment types.
Mutual Funds
These funds are typically bought and sold through Asset Management Companies (AMCs) instead of on stock exchanges, and therefore, unlike publicly traded ETFs, they do not always have trading commissions.
However, they almost always charge an annual management fee, commonly referred to as an expense ratio, and other transaction-related and account maintenance fees.
Mutual funds offer three major benefits:
Convenience– By investing in a mutual fund, you get to own a basket of different stocks all in one package. A mutual fund could have many different stocks in it, but you only have to make one purchase. If you wanted to have 50 different stocks in your portfolio, you would have to make 50 separate purchases in a world without mutual funds. That means you pay trading commission 50 times, and you would waste a lot of time buying all the stocks separately. But by investing through a mutual fund, you get instant ownership in all the stocks, the mutual fund already holds. Having many stocks all at once gives you diversification, which is the second major benefit of mutual funds.
Diversification– Diversification is a strategy that reduces your investing risk by spreading out your investments. Instead of putting all your money in one stock, you spread out your money across many different stocks. If any stocks in the mutual fund crashes, you will still be okay because each stock is only a small chunk of your overall portfolio.
Professionally Managed– The third benefit of mutual funds is that investment professionals manage them. So instead of trying to find stocks on your own, you have some highly qualified professional fund manager who is picking stocks on your behalf.
But that doesn’t mean mutual funds are always good. Convenience and diversification are good benefits but having professional fund managers charge a lot of fees. When a highly qualified professional is picking the stocks for your mutual fund, they charge an annual fee of 1-2% of your investment every year in return for managing your money.
And even if the fund manager makes poor investment decisions and your investment actually goes down next year, you still get charged 2%. You could finish up with less money than you started with, but the fund manager would still get paid millions of rupees for their services. Even if you find a fund manager who has done well in the past, their performance usually does not last over the long run, and the cost of fees can add up.
Then came the index fund, which transformed the investing outlook. Unlike traditional mutual funds, index mutual funds are passively managed. That means that rather than paying an expensive fund manager to do active management, the fund follows a fixed formula that eliminates someone’s need in making buying and selling decisions. The fund manager invests your money in the stocks exactly in the same proportion that they are in the index.
An index is a representative sample of the stock market, and indexes were created as a tool to measure stock market performance quickly. Rather than looking up hundreds of stocks individually, an index is just one simple thing, and you can look up to see how the stock market did that day.
There are two indices in India, i.e., Sensex and Nifty. The index funds mirrored the Sensex 30 and Nifty 50. Since the fund buys whatever stocks are in the Sensex and Nifty, the fees are much lower because you’re not paying for expensive fund managers to make these decisions for you.
ETFs
ETFs or exchange-traded funds are the funds that are traded on the stock exchange. So very similar to a mutual fund, an ETF is holding a group of stocks or bonds included in one fund. But the main difference is that an ETF is traded on an exchange just like a stock, i.e., that you can buy and sell ETF throughout the trading day from 0915 hrs to 1530 hrs.
Because you don’t have to wait until the end of the day to buy an ETF like you do with a mutual fund, this can be a good or bad thing. That means that you can take advantage of any big drops or any big gains in the market by either buying or selling the ETF you own. But this also means that you could make some unnecessary trades just because you are trying to keep pace with whatever is going on in the news for that day.
For instance, if any bad news pops up in the market, many people may have been buying or selling in and out of the market, whereas if you owned a mutual fund, you would only be able to do it at the end of the day. It may stop you from making any rash decisions based on what news is going on in the market during the middle of the day.
So, ETFs do more harm than good. So, if you do not know whether you should go with ETFs or index funds, it is better to choose index funds. They are essentially the same thing, but you won’t have the added temptation to gamble with your money. If you have to buy once, hold them for the long-term; you don’t need the 24/7 tradeability of an ETF.
Another benefit that mutual funds offer is an automatic investment. If you like to repeat specific transactions automatically, an ETF would not be a suitable investment. ETFs would not offer this feature if you wanted to contribute more to your investments every month. You would have to buy more shares of the ETF every month, which means more work for you, and you have to pay the trading commission’s every time.
A mutual fund could be a suitable investment. You can set up automatic investment and withdrawals into and out of mutual funds based on your preferences. The best thing is that there is no additional charge for doing this. It is a free automatic investment feature, and it makes it a no-brainer for you to automate good investing habits.
So, I hope you have a better understanding of mutual funds, index funds, ETFs and their similarities and differences. Mutual funds came first, and they offered the benefit of pooled investing. After that, index funds came along as a special type of mutual fund with much lower fees and a type of management called passive management. Finally, the ETF came into the picture that trades like a stock and offers everything that index funds offer except automatic investment.
ETFs tend to have a more passive investment approach. Like index mutual funds, ETFs tend to have very low expense ratios and tend to be more tax-efficient. However, they do involve trading commissions, although some brokerages offer commissions-free trading.
Mutual Funds vs ETF: Conclusion
Regardless of which option you choose, investors need to remember that the most important thing they can do is save and regularly invest while achieving maximum time in the market for their savings to let the magic of compounding work for them, enabling them to achieve their long-term financial goals.
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