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Mutual Funds vs. ETFs: What’s The Difference?

Read this blog to know how mutual funds and exchange-traded funds (ETFs) match up to each other. Find out why mutual funds are known to generate better returns than ETFs.
July 14, 2021

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Mutual funds and ETFs are investment options that are connected to the market. Investors can buy and sell mutual funds and ETFs to create long term wealth. 

The average Indian investor is more aware of the ins and outs of mutual funds than ETFs. The reason behind this is twofold. Mutual funds have been available to Indian investors since the early 1960s. 

ETFs, on the other hand, were launched in India during the early months of 2001. The other reason is the sheer volume of options available. 

Indian investors can choose from over 1000+ mutual fund scheme variations. In comparison, there are approximately 100 ETFs on the Indian market.  

Similarities Between ETFs And Mutual Funds

Mutual funds and ETFs have a few things in common. To start with, both of these assets invest in market-linked securities like stocks and bonds. They may even invest in other mutual funds or ETFs. 

Both mutual funds and ETFs offer a means for diversification and are professionally managed. But the degree of management marks one of the key differences between mutual funds and ETFs. 

Difference Between Mutual Funds And ETFs

1. Types Of Mutual Funds & ETFs

Mutual funds are broadly categorized into two types: open-ended and close-ended mutual funds.

A. What Are Open-Ended Mutual funds?

  • Most common type of mutual fund on the market 
  • Investors can buy and sell units at any time
  • No limit on the number of shares the fund house can issue
  • Requires daily disclosure of NAV

B. What Are Close-Ended Mutual Funds?

  • Rare in comparison to open-ended mutual funds
  • Investors can only buy units during NFO
  • Limited number of units available to investors
  • Carries a fixed lock-in tenure
  • Price based on investor demand, not NAV
Investment Facts

ETFs are classified into 4 types in India: Index ETFs, Gold ETFs, Sectoral ETFs & International ETFs.

A. What Are Index ETFs?

  • Mirror the portfolio of an index like the S&P 500 or Sensex
  • Returns are generally similar to the underlying index
  • Treated as an equity instrument during taxation

B. What Are Gold ETFs?

  • Track the price of gold bullion
  • Returns generally similar to gold bullion price
  • Treated as a non-equity instrument during taxation

C. What Are Sectoral ETFs?

  • Track a specific sectors or themes like power or energy
  • Treated as an equity instrument during taxation

D. What Are International ETFs?

  • Invests in indices, themes, sectors, etc. across foreign countries
  • Treated as a non-equity instrument during taxation

2. Difference In Management Styles: Mutual Funds Vs ETFs

Most mutual funds are actively managed. Index funds are the only exception to this norm. Actively managed funds are operated by a fund manager and a team of analysts.

The fund management team regularly monitors the market for buying and selling opportunities. The management style for ETFs is the exact opposite of mutual funds. 

ETFs are passively managed which means that the Asset Management Company will build a portfolio of securities only once. That’s because ETFs are designed to mirror an index, for example, the S&P 500

The AMC will periodically return to the ETF to rebalance holdings but overall, there won’t be a fund manager or team of analysts that are trying to monitor the market to improve the ETF’s performance.   

3. Investment Goal

The goal of a mutual fund is to outperform the market. Performing on par or below the benchmark is simply unacceptable for most fund houses. That’s why they hire a dedicated fund manager and a team.

The goal of an ETF is to mirror an index’s portfolio and returns. Thus, ETFs will simply grow with the market/index, not outperform it, while generating relatively predictable returns. 

4. Mode Of Investment

Mutual funds can either be bought directly from a fund house or through an app like Cube Wealth. ETFs are bought and sold like a stock on an exchange like the NSE or BSE.

5. Liquidity

Certain mutual funds like liquid funds are relatively more liquid than international funds. But on average, it takes approximately 3-5 business days to redeem a mutual fund investment. 

Unless you have Cube ATM, that is. Cube ATM allows you to instantly withdraw up to ₹50,000 or 90% of your investment in the Nippon India Liquid Fund.

ETFs can be sold instantly just like regular stocks. However, the liquidity of an ETF will depend on the liquidity of its underlying components.  

6. Price 

Both mutual funds and ETFs have a price indicator known as Net Asset Value (NAV). The NAV of a mutual fund or ETF is calculated at the end of each trading using the formula:

NAV = Assets - Liabilities/total number of shares outstanding

However, ETFs have another price indicator - the value at which they can be bought and sold on a stock exchange. The two price indicators are ever so slightly different. 

Overall, ETFs are known to be more cost-efficient than mutual funds because of the low expense ratio or management fee. 

Mutual Funds Vs ETFs Performance

The average returns generated by mutual funds and ETFs varies due to the investment goal as evidenced by the graph below.

Comparison of average return rates for ETFs, Mutual Funds and Debt Funds

Explore Top Mutual Funds

How Are Mutual Funds And ETFs Taxed?

Investment

Short Term Capital Gains

Long Term Capital Gains

Equity Funds

15%

10%

Debt Funds

Income Tax Slab

20%

International Funds

Income Tax Slab

20%

Index & Sectoral ETFs

15%

10%

Gold & International ETFs

Income Tax Slab

20%

Read this blog to know how you can avoid tax saving mistakes in 2021

Should You Invest In Mutual Funds Or ETFs?

Your risk profile, investment goals, and the type of investor you are will determine whether you should invest in mutual funds or ETFs. 

Legendary investors like Warren Buffet suggest investing in index ETFs because they’re known to generate returns on par with the underlying index. Moreover, the expense ratio is low as well.

However, top mutual funds like equity funds and international funds can potentially outperform the market. Furthermore, debt funds and liquid funds are known to comfortably beat regular bank FD returns.  

Watch this video to find out how you can avoid a classic investing mistake


Shriram Shekhar
Shriram is a Content Marketer at Cube Wealth, the Financial Freedom App with a smart Perfect Portfolio Planner. He has developed cutting edge IT products for over 2 years before turning to his passion for the written word. Shriram’s love for philosophy, product development, and empowering people through quality content is what got him to Cube Wealth.

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