Mutual funds and ETFs are two popular investment tools. A mutual fund is a type of collective investment scheme that is professionally managed. It pools the money from several investors before investing it in various securities, such as stocks, bonds, short-term money market instruments, and other types of securities.
At the same time, exchange-traded funds are a type of fund that may be bought and sold on stock markets. It often follows a stock index as it is.
But which among them is better for you? Let us compare.
What is a mutual fund?
A mutual fund is a type of investment vehicle in which several participants pool their money together. This system gathers funds from many individuals and then invests in financial securities such as shares, debt, or liquid assets. In a mutual fund, all of the risks, rewards, profits, and losses that come out of this pool of funds are shared by the investors, and this sharing is done in proportion to each investor’s contributions to the fund. When you purchase a unit in a mutual fund, you become the owner of a fractional interest in each investment that the fund as a whole holds.
Every investor has a variety of objectives that they want to accomplish through the use of mutual funds. Some of these objectives may have a more immediate time frame, while others may be more far-reaching.
What is an exchange-traded fund?
Exchange-traded funds, or ETFs, let you pool your money to buy a variety of bonds or stocks all in one convenient package. Most of the time, they follow a market index, such as the Nifty 50. They function similarly to index funds, which likewise follow the performance of a market in this regard. The deciding factors are how they are bought and sold and any associated fees.
Exchange-Traded Funds are traded on the stock market instead of other funds. It means you can make a purchase or sale at any time of day.
Trades in other types of mutual funds occur just once each day. This means that while you can submit a purchase or sell order at any moment, the transaction itself may take some time to process. As a result, the transaction will be completed at the next “trading point,” which is often the end of the business day.
ETFs vs. Mutual funds
- ETFs usually have high daily liquidity and lower fees than most mutual funds, making ETFs an attractive alternative for individual investors.
- ETFs are handled in a hands-off manner. Since the goal of an exchange-traded fund is to replicate the performance of a specific market index, this investing is known as passive management.
- ETFs have lower administrative expenses than actively managed portfolios since they replicate an index’s performance without attempting to exceed it.
ETFs tracking error
ETFs and Index Funds incur expenses for marketing, advertising, office management, brokerage, and so on, just like they are by other mutual fund investment. These costs weigh down the ETF’s returns. On the other hand, the ETF’s performance may momentarily outperform the benchmark if it receives dividends from the underlying companies. Known as the “tracking error,” this performance discrepancy is quantified as a percentage. Active risk is another name for tracking errors. The inflow and outflow management of an index fund also plays a role in establishing the fund’s tracking inaccuracy. The superiority of an ETF or Index fund increases in proportion to its tracking error.
The choice between a mutual fund and an ETF often boils down to personal investment preferences. Therefore, the above information should be adequate for you to compare and decide.