Stock market investments are an option that is known to give higher returns. But at the same time, the investment option requires you to be highly alert and knowledgeable as markets can move in a matter of seconds, and timely intervention is often needed. But what if an experienced fund manager does this for you? Mutual funds and exchange traded funds provide you with this option. In both cases, a fund manager collects money from different investors and invests in a portfolio that matches the fund’s theme. But are they the same? If not, how do mutual funds and ETFs differ? Read on to find out.
What are mutual funds?
As said above, in the case of a mutual fund, a fund manager pools money from different investors interested in investing in the fund and creates a portfolio in which their money will be invested in. Here, there is active participation from the fund manager for most mutual funds. That means the fund manager changes the composition of the portfolio every now and then to maximise the investor value. As a result of this, a portion of the money you invest goes towards paying the fund manager as well. This is called the expense ratio.
What are ETFs?
ETFs work similar to that of a mutual fund. Here too, money is pooled from different investors and is invested in a pre-fixed portfolio. The main difference here is the composition of the portfolio. In the case of mutual funds, portfolios are created according to the fund’s theme at the fund manager’s discretion. But in the case of ETFs, they blindly follow an index rather than making a portfolio of their own. For instance, an ETF that tracks BSE Sensex will have a portfolio composed of all the components of the index.
Mutual funds vs ETFs- what should you choose?
The choice between mutual funds are ETFs can depend on a few factors. Let’s discuss them.
Market knowledge
As mentioned above, mutual funds have a fund manager that actively interferes with the portfolio and performance of the fund. This means that the manager does a lot of market research when managing the portfolio. This saves you from having to do strenuous study and finding a composition that will work for you.
At the same time, for an ETF, you have to depend on your knowledge and research as they track indexes as it is and are passively managed. This can potentially increase the risk of your investment too.
Expense ratio
The expense ratio is a fee that the fund houses charge for their expenses related to managing the fund. Since mutual fund managers actively manage them, the expense ratio tends to be higher comparatively.
In the case of ETFs, since the management is passive, the expense ratio tends to be much lesser.
Although the expense ratio tends to be just a tiny percentage of your investment, it can potentially eat into your returns if returns are lower.
Liquidity
The most significant difference between the two lies in their liquidity. Although most are considered to be reasonably liquid, ETFs are more liquid than mutual funds. This is because of the fact that ETF is tradable like a stock. That means you can sell or buy your ETF unit anytime compared to mutual funds, where you might have to wait for a day or two to redeem.
Conclusion
ETFs and mutual funds are good options to invest in the stock market indirectly. Talk to your investment advisor to figure out what works better for you.
