ETFs vs Mutual Funds: What's the difference?
Let's have a look at the distinction between the two!
There are basically two ways you can have exposure to the stock markets. One is direct investment, wherein you open a demat account and invest in the market through a broker. The second one is indirect investment wherein you entrust your funds to an expert or an investment process, and they make investments on your behalf in exchange for which you pay a certain fee or charge. In India, mutual funds have become a popular vehicle for indirect investments. Another form of indirect investment is exchange traded fund (ETF), which is in a nascent stage of popularity in India. However, investors in the US and European nations have greater investments in ETFs.
So the question that arises is, how are these two instruments different? These two instruments have many similar characteristics. Both include a mix of different assets. The main difference between the two is the way they are managed.
Let’s first understand what they really are.
A mutual fund is a professionally managed investment fund that pools money from investors to invest in various financial instruments like stocks, bonds, and other assets for which an investor pays management fees, generally in the range of 1 to 2 per cent.
Just as the name suggests, ETFs trade on exchanges just like normal stocks which aim to track the index, sector, commodity or other assets.
The key difference between the two is that mutual funds are usually actively managed and ETFs are mostly passively managed. The mutual funds are managed by a fund manager, who is expected to beat the market and generate higher than benchmark returns. This is why mutual funds have relatively high management fees. On the other hand, ETFs are subject to minimal human intervention. It is mostly run by algorithms, which follow a specific mandate, for example, tracking the Nifty index. An investor who wishes to have exposure to the Nifty index may consider investing in that particular ETF. And since it is passively managed, the management fees are minimal.