ETF vs. Mutual Fund: Check Out How They Differ

May 31, 2022

Areej M Alturki
Founder, Nakla

When it comes to investing your hard-earned cash, your financial consultant will most likely propose ETFs and mutual funds. The similarities between both financial instruments might easily mislead an investor. However, specific characteristics make ETFs vs. Mutual funds different from each other.

When it comes to choosing between the two, many traders have no choice. However, you may leverage both of them together and strategically to develop an investment portfolio. This totally depends on your financial goals and investing period.

Exchange Traded Fund Overview

The exchange-traded fund is described as an investment fund that is traded on the stock exchange. The assets owned by an exchange traded funds are stocks, commodities, and treasuries. These are traded for a cost similar to the authentic NAV of the asset as per the trading day. 

There are several ETFs that follow a treasury index or a stock market index. The ETF's worth might fluctuate throughout the day. They are less expensive and have superior cash flow performance than mutual fund shares. ETFs can be utilized to accomplish a variety of goals, including hedging, arbitrage, and many more.

Mutual Funds Overview

Mutual funds are defined as actively managed investment schemes that pool cash from several participants and spend it in broad holdings. Mutual funds invest in a massive assortment of securities, including shares, treasuries, debt instruments, and other assets. Every plan has a predetermined NAV that is calculated by dividing a mutual fund's large budget by the group of shareholders.

Expert fund managers or teams professionally handle most mutual funds. They make crucial decisions to buy and trade equities or any other securities within that fund with the aim to excel in the market and assist their investors in earning profit. These funds are typically more expensive since they necessitate way more time, energy, and labor for data and testing securities.

Similarities between ETF and Mutual Funds

Both Provide Diversification

Because mutual funds and ETFs are a collection of numerous equities, they both gain from diversification. As a result, if one stock underperforms, there is always the potential that another may outperform well. This allows you to hedge your risks. Diversification renders them less hazardous than investing in individual securities.

Both Provide a Broad Range of Investment Opportunities

ETFs and mutual funds provide access to a diverse range of domestic and foreign shares and bonds. You can generally invest (for instance, in a whole market fund), specifically (in a high-dividend stock fund or specialty fund), or somewhere in between. It all comes down to your specific objectives and investing approach.

Both Follow Passive Investment Methodologies

ETFs and index funds both use a passive investing approach wherein they get the opportunity to invest in assets in almost the same ratio as the indexes they track. This implies that the fund will have a similar weightage as every item in the index. They both want market returns at a cheap cost.

Both Collect Investors from Various Investors

One of the commonalities among mutual funds and ETFs is that money from many users is gathered together and invested in various securities, which can be stocks, debt, or commodities such as gold. Professionals then manage this fund.

Both Comprise NAVs

ETFs, just like mutual funds, comprise net asset values computed at the end of each day. Both the financial instruments get their worth from the underlying securities they invest in. Also, the NAVs are computed in a similar manner. In both scenarios, the growth and decline in the worth of NAVs highlight the ETF or mutual fund achievements.

Both are Handled by Expert Fund Managers

Experts handle ETFs and mutual funds. These professionals select and analyze the equities and securities in which the funds are invested, sparing you time and energy.

Even though most of these funds are index funds, investment managers are still available to ensure that the funds do not deviate from their prospective indexes.

Key differences between ETFs and Mutual funds

ETFs and mutual funds are other investing concepts that appear to be similar. And while they're commonly mentioned together, they're entirely different assets in reality. Both financial instruments comprised potentially hundreds of distinct stocks.

However, how they are handled and employed in an investment portfolio might differ significantly.

Let's look at the distinctions between ETFs and mutual funds.

ParametersETFsMutual Funds
FlexibilityYou can trade ETFs freely on the market and buy and sell them at your convenience. The market price of ETFs are present in real-time, just like equity shares.Mutual funds can be bought or sold by submitting an application to a financial institution. The NAV is the value of one share of a mutual fund.
Buying and Selling ProcessETFs are traded throughout the trading day, and their worth differs during this tenure.Mutual Funds are traded at the closing NAV of that specific day.
CommissionsBecause ETFs are traded on the market just like other stocks, investors are required to pay charges for selling and buying units according to the regulations.While investing in mutual funds, you don’t require to pay any commission for trading.
Operating ExpensesETFs have reduced operational costs.The operational expenditures of this financial instrument vary.
Tax BenefitsETFs give tax benefits to its users. All thanks to the manner they are established and redeemed.Coming to Mutual funds, it has comparatively greater tax obligations than exchange-traded funds.
Lock-in PeriodETFs have no limited holding time, and hence the investors can trade the investment whenever they choose.Mutual funds, such as Equity Linked Savings Scheme, have a three-year lock-in term. It is not permitted to withdraw the stake within this period. This might vary between 9 days to 3 years based on the plan chosen.
Transaction CostWhen dealing with ETFs, there seems to be an extra cost known as the "bid-ask spread."When you plan to invest in this financial instrument,, the transaction amount is often nil compared to ETFs.
IndexETFs attempt to mirror the price fluctuations and returns of an index. This is done by creating a portfolio that is comparable to the index components.Mutual fund track indexes but is controlled by specialists. Assets are chosen in a way that they outperform the index and produce high results.
LiquidityETFs have more liquidity because they are not associated with their everyday trading volume.Mutual funds have less liquidity in comparison to ETFs.
Minimum ExpenseThere is no specific amount mentioned that you need to spend while choosing to invest in ETFs.The minimal amount to spend in mutual funds is mentioned for most funds.

Conclusion

Though both are oriented toward sole investors, ETFs have gained immense popularity lately as a perfect economical alternative to mutual funds. ETFs provide cheaper charges and no minimum spend requirements (other than the cost of a sole share). Despite outweighing ETFs, mutual funds provide more fantastic choices and the opportunity to beat the market.

ETF vs Mutual Fund FAQs

Is it better to invest in ETF or mutual fund?

The primary distinction between a mutual fund and an electronic traded fund is that the latter provides intraday liquidity. Hence, if the expertise to trade like a stock is crucial to you, the electronically traded fund may be the superior option.

Are ETFs riskier than mutual funds?

Mutual funds and exchange-traded funds (ETFs) are considered reasonable investments compared to individual equities and bonds. While all investments entail some amount of risk, mutual funds and ETFs have about the same level. It is dependent on the specific mutual fund or ETF in which you are investing.

Are mutual funds more liquid than ETFs?

No, mutual funds are less liquid than exchange-traded funds. ETFs are more liquid as they trade similar to stocks on stock exchanges. They may be purchased in the same way just like stocks. You don’t require to go through multiple fund families and their particular redemption processes. 

How is an ETF different from stock?

While stocks are only one type of instrument, an ETF is a collection of broad investments such as stocks, treasuries, and other instruments. The fund management then sells the stakes in these assets to investors. Moreover, an ETF investment has a lesser risk since it is diversified. On the other hand, stocks might be riskier, mainly if you invest all your money in one stock.

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