In life, there can be several instances when you have to take tough financial decisions. In such situations, you must assess all the odds and consider how choosing one option may affect your life going forward.

However, when it comes to choosing between ETFs vs mutual funds, you do not have to take much stress. They have their own set of similarities and differences that make them ideal investment vehicles for different types of investors. 

Keep reading this blog, and you will know what to do!

What Are Mutual Funds?

Mutual funds are investment vehicles that collect money from several individuals and invest a sizeable corpus in different types of assets. Based on their types, these schemes can invest in a variety of securities like stocks, bonds, commodities, and more. 

The investment objective of mutual funds is to offer diversification to the investors and generate expected returns; the fund managers are always trying to manage the asset allocation, either actively or passively, in order to achieve this feat. 

However, like all investment options, there are risks associated with mutual fund investments. For debt mutual funds, there are interest, credit, and inflation risks. While in the case of equity mutual funds, the risks are volatility and liquidity.

What Are Exchange Traded Funds (ETFs)?

Exchange-traded funds (ETFs) are a type of mutual fund scheme, the units of which are tradable on stock exchanges. Fund managers usually invest in stocks of a particular underlying index and aim to replicate its returns with minimum tracking error. 

Unlike traditional mutual funds, the prices of ETF units change throughout the day depending upon their demand and supply. The units are tradeable on the stock exchanges, just like shares. Moreover, most of these schemes are passively managed, which means that the fund managers periodically make only minor changes to the fund’s portfolio so as to keep the returns in line with that of its underlying index. 

ETFs and Mutual Funds – How Similar Are They? 

To choose one between ETF vs mutual fund, you need to know the points on which they are similar:

1. Have Similar Structures

One of the biggest similarities between ETFs and mutual funds is that they have similar structures.

The assets in both schemes are managed by financial professionals who collect a large corpus from several individuals to invest in different assets. Moreover, both these investment vehicles have Net Asset Values (NAVs), which reflect the scheme’s performance. 

2. Facilitate Diversification

As both schemes invest in a variety of securities, they offer diversification to investors. This feature helps reduce risks as losses from one asset can be offset by profits from the other. 

3. Have No Lock-in Period

Usually, both mutual funds and ETFs do not have a lock-in period. However, some schemes like ELSS and close-ended mutual funds have a minimum lock-in period when investors are not allowed to redeem their holdings.   

4. Follows a Stock Market Benchmark

There are some types of ETFs and mutual funds that make investments based on a particular stock market index.

The fund managers invest in securities while trying to replicate the return of a particular underlying benchmark. 

5. Tax Implications

The profit you earn from the sale of both mutual fund and ETF units comes under capital gains tax. As per Section 112 of the Income Tax Act, if you redeem your holdings after a period of more than 12 months, LTCG is applicable at the rate of 10%. Conversely, if you exit your position before this period, you are liable to pay STCG at 15%. 

*Tax implications mentioned above are only applicable for equity, index and sectoral funds. 

Differences Between ETFs and Mutual Funds

To help you decide which is a better investment option between ETFs vs mutual funds, check out the table below:

ETFs or Mutual funds – Which One to Choose?

When it comes to choosing the better of ETFs vs mutual funds, all it can be said is that it totally depends on your investment objective. 

You can consider investing in exchange-traded funds in case you: 

1. Indulge in Active Trading

When trading ETF units actively on the stock exchange, you can use stop-limit orders in order to prevent losses. Moreover, you can also take advantage of intraday price movements for booking profits. This is only possible in the case of ETFs and not traditional mutual funds. 

2. Want Short Term Returns

As ETF units can be sold easily on stock exchanges, they provide you with high liquidity. It enables you to take advantage of short-term price movements when the values of underlying assets reach a certain high.  

A few of the top ETFs in India are – Motilal Oswal NASDAQ 100 ETF, HDFC S&P BSE Sensex ETF, SBI S&P BSE Sensex ETF, Edelweiss Nifty 100 Quality 30 Index Fund, and UTI S&P BSE Sensex ETF.

Before you buy ETF units, a few things that you need to consider are the underlying index, Assets Under Management, liquidity, total expense ratio, and tracking error. Moreover, you should also assess the fund’s performance in the last 5 years.

Alternatively, you can choose to invest in mutual funds if you want to:

3. Stay Invested for the Long Term

Mutual funds have lower liquidity in comparison to ETFs. Thus, they are suitable when you have a long-term investment horizon and wish to stay away from the intricacies of short-term price fluctuations. Moreover, these assets can also be helpful when you want to build a large corpus over a significant time period. 

4. Invest Periodically

These schemes offer the benefit of Systematic Investment Plans (SIPs), which allow you to make monthly or quarterly investments.

So, if you wish to have a disciplined approach to making investments after a specific period of time, mutual funds are the way to go. Additionally, opting for SIPs can help you leverage rupee cost averaging, which can provide you stable returns even in times of inflation.   

Quant Small Cap Fund Direct Plan-Growth, Quant Tax Plan Direct-Growth, Tata Digital India Fund Direct-Growth, ICICI Prudential Technology Direct Plan-Growth, and SBI Technology Opportunities Fund Direct-Growth are some of the best mutual funds you can invest in 2023. 

Conclusion

Now that you have a clear idea of ETFs vs mutual funds, you can select one which aligns with your investment objective. However, please remember, like all financial assets, they are also subject to market risks.

Several micro and macroeconomic factors, like interest rate changes, geo-political events, war, recession, etc., can affect the return on investment. Thus, it is advisable to assess your risk tolerance before making an investment.