Difference Between Mutual Fund vs Exchange Traded Fund
A mutual fund is a professionally managed investment vehicle created by pooling money from several investors for the purpose of investment in a wide range of securities like stocks, bonds, money market instruments, and other assets. Through this vehicle, small or individual investors are able to access the securities or asset markets while reducing risk through cheaper and faster diversification, economies of scale, and the expertise of professional money managers. now we will discuss the Mutual Fund vs Exchange Traded Fund.
To understand diversification benefits, assume that one of the stocks in the mutual fund portfolio is doing poorly while another stock is doing very well. The risk is mitigated as losses from one stock can be nullified/reduced by gains in another stock. Thus you will be better off investing in a mutual fund rather than investing in one stock or few stocks of the fund portfolio.
An average mutual fund holds hundreds of securities, hence, investors get to reap benefits from capital gains of different securities through their proportionate share which would not be possible in the case of individual investment in each of these securities owing to funding constraints. Mutual fund units are bought through the fund management company selling the mutual fund.
Exchange-traded funds (ETFs) are an extension of mutual funds which are traded on the stock exchange just like company shares giving the investor the flexibility to sell short or buy on margin during the trading hours in a day. ETF shares can be bought through a brokerage.
Head To Head Comparison Between Mutual Fund vs Exchange Traded Fund (Infographics)
Below are the top 5 differences between Mutual Fund and Exchange Traded Fund:
Key difference between Mutual Fund vs Exchange Traded Fund
Both Mutual Fund and Exchange Traded Fund are popular choices in the market; let us discuss some of the major differences :
- Unlike Mutual funds, ETFs are traded on a public stock exchange. Hence, like shares of public companies, ETF shares can be transferred, bought, or sold among investors
- Mutual funds units are directly purchased from the funds at a single NAV value fixed during the trading hours of the day. You can buy and sell ETF shares anytime during the trading hours and the market decides the price based on demand-supply dynamics at any point in time. Hence the price of ETF units keeps changing throughout the trading hours thus providing real-time pricing and greater control of the price of your trade
- Due to their manner of creation and redemption, ETFs incur capital gains taxes only when the investor sells the fund. In contrast, mutual funds incur capital gains tax every time they trade the shares. Hence tax liability is higher for mutual funds compared to ETF
- The transaction cost for buying or selling mutual fund units is zero. However, ETFs have a transaction cost involved in the form of bid-ask spread just like other exchange-traded shares
- Most Mutual funds have an investment lock-in period of minimum 90 days and impose a penalty in case the investor wants to liquidate his holdings prior to the lock-in period. Since ETFs are exchange-traded, you can trade your unit with other investors at the prevailing market price during the trading hours. There is no minimum holding period
- Like public company shares, ETF units can be sold short or bought on margin. ETFs can thus be used for hedging, equitizing cash, or arbitrage
- Unlike ETFs, Mutual funds will provide you with the opportunity to preset automatic investment and withdrawals as per your preferences
- Most mutual fund managers have the independence to choose their investments and actively manage their portfolio to beat the index they track. Most ETFs are index funds and passively managed by the professionals where they try to match the movements and returns of the tracked index by maintaining a similar portfolio like that of the index
Mutual Fund vs Exchange Traded Fund Comparison Table
Below is the Comparison Table between Mutual Fund vs Exchange Traded Fund
| The basis of Comparison | Mutual Fund | Exchange-Traded Funds |
| Cost-effectiveness | Comparatively higher since they are actively managed with high trading activity and volume of transactions, requiring larger operating fees and commissions | Comparatively lower since they are usually passively managed index funds |
| Tax Efficiency | Comparatively more tax liabilities | Offer capital gains tax benefits due to the manner of their creation and redemption |
| Minimum investment | Most Mutual funds have a minimum investment limit specified in their terms. This amount is higher than the net asset value (NAV) of one unit of the fund | ETFs are not constrained by any minimum investment. You can be an ETF investor by buying just one unit of the fund |
| Liquidity | Mutual funds have comparatively lower liquidity | ETFs have higher liquidity and its liquidity is connected to the liquidity of stocks included in the index |
| Brokerage account | Investors do not need to open a brokerage account to invest in a mutual fund | A brokerage account is necessary to trade ETF units in the stock exchange |
Conclusion
Mutual Fund vs Exchange Traded Fund provides similar investment opportunities to small investors who are constrained by funds and expertise from individually investing in a large diversified portfolio of assets including stock, bonds, commodities, etc. Both Mutual Fund vs Exchange Traded Fund investment vehicles offer high diversification benefits in the form of better returns at a lower cost. Both Mutual Fund vs Exchange Traded Fund offer a wide variety of investment options and based on your preference you can invest broadly like in a market fund or narrowly like in a sector fund. Further, both these investment vehicles are administered by professional portfolio managers who will offer you their expertise and save your time and effort.
However, ETFs provide several benefits over mutual funds like a lower minimum investment, more control over price, lower capital gains tax benefit, trading simplicity, lower commission and management fees involvement, and cleaner transferability options while switching from one investment firm to another. On top of that, ETFs provide higher investment flexibility as they come with several innovations in their trading strategy like style ETFs, inverse ETFs, country ETFs, etc. offering a greater opportunity of attaining their specific financial goals.
Still, the question remains whether ETFs are better than Mutual funds or vice-versa. This largely depends on the preference of the investor. If the investor prefers a lower minimum investment, he will opt for an ETF. If he wants repeated automatic transactions, he should go for mutual funds. If he wants control over the pricing, he should go for an ETF. If he does not want the hassles of opening and maintaining a brokerage account, he should opt for a mutual fund. If he is looking for an index fund with a lower risk, an ETF could be a more suitable investment.
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