The future brings uncertainty with it. Financial security reduces the risks and uncertainty that might come in our future. Therefore, securing your financial future is one of the most crucial tasks to perform. There are a huge variety of options available for you to invest in as per your financial goals. Investing your money will ensure generating higher returns.
ETFs and Mutual Funds are among the most popular options for investment in India. Both of them seem quite similar but by giving a closer look one can understand the differences.
MUTUAL FUNDS: They can be understood as investment schemes that are professionally managed to collect money from various investors to further invest in diversified holdings. Mutual Funds invest in a variety of securities such as stocks, bonds, debt instruments, etc. NAV of each scheme is defined by dividing the total investment of a mutual fund by the number of investors.
Mutual Funds provide the option of minimum investment. ETFs on the other hand asks for a comparatively bigger amount. Mutual Funds are actively managed by the fund company. The company decisions to buy and sell stocks and other securities within that fund amount to compete in the market and help the investor earn a higher amount of profit. These funds are relatively costlier as they need a lot more time, effort, and manpower.
The process of purchase and sale of the Mutual Funds is directly between the investors and the fund. The price of the fund is only determined after the Net Asset Value (NAV) is determined.
KINDS OF MUTUAL FUNDS
Legally Mutual Funds has two classifications:
- Open-ended funds: The mutual fund market place is dominated by these funds in volume and assets under management. The purchase and sale of funds with open-ended funds are between the investors and the fund company. The fund can issue an unlimited number of shares. More shares are issued to attract more investors. A daily valuation process is required for Federal Regulations called marketing to the market. It adjusts the fund’s per-share price so that changes are reflected in the portfolio (asset) value. The number of shares outstanding does not affect the value of an individual’s shares.
- Close-end funds: These funds issue a limited number of shares. If investor demand grows, they do not issue new shares. Net Asset Value (NAV) does not determine the prices of the fund instead are driven by investor demand. Purchases of shares can be made at a premium or discount to Net Asset Value (NAV).
ETFs: Exchange Traded Funds merely replicate and index. They cost far less for an entry position. Institutional investors and the shares trade create or redeem an ETF in large lots throughout the day between investors like a stock. ETF can be sold short like a stock. As ETFs are priced constantly by the market, there is the possibility for trading to take place at a price other than the true NAV, which may open an opportunity for arbitrage. ETFs offer a tax advantage that can attract more investors. In contrast to actively managed Mutual Funds, ETFs realize few capital gains as ETFs are passively managed portfolios.
All the stocks in this fund are held in the same weight as by the underlying index. ETFs are traded on the stock exchange actively. They can be purchased freely and sold throughout the trading session.
The way ETFs are created and redeemed, they prove to be more efficient than Mutual Funds.
KINDS OF ETFs
ETFs can be classified into three categories.
- Open-End Index Mutual Funds: Exchange-traded open-end Index Mutual Funds are registered under the SEC’s Investment Company Act, 1940. Under this fund, dividends are reinvested on the day of receipt. Then they are paid to shareholders in cash quarterly. The lending of securities is allowed.
- UIT (Unit Investment Trust): Exchange-traded UITs are also registered under the Investment Company Act, 1940. UITs pay their dividends in cash dividends and do not automatically reinvest dividends. Some of the examples of UIT include the QQQQ and Dow DIAMONDS (DIA).
- Grantor Trust: This category of ETF resembles strongly to a close-ended fund. But here the underlying shares are owned by the investor in the companies where ETF is invested. The composition of the fund remains the same though. Dividends are paid directly to shareholders and are not reinvested.
MUTUAL FUNDS V/S EXCHANGE-TRADED FUNDS (ETFs)
While investing choosing between Mutual Funds and ETFs might seem a little confusing and tricky but if you know the key difference then the decision-making process becomes a lot more smooth. Though they might seem quite similar there are a few key differences between the two:
- FLEXIBILITY: ETFs are traded freely. They can be bought and sold in the market according to the convenience of the investor. Just like ordinary equity shares, the market price of EFTs is available in real-time. Only by requesting the fund house, Mutual Fund units can be bought/sold. The price of one unit of Mutual Fund is indicated by NAV.
- EXPENSES AND FEES: ETFs just replicate the performance of an index, so they do not need active management. This is the reason behind the low fees and expenses associated with ETFs investment.
- COMMISSIONS: Commissions on sale and purchase of units are need to be paid by the investors as per the prevailing rules. This is because ETFs are traded like any other share on the exchange. Any commission is not necessary for the sale and purchase in the case of Mutual Funds.
- MANAGEMENT: For managing Mutual Funds actively an experienced fund manager is needed who can take all management decisions efficiently on behalf of the investors. Funds rarely track the market index in the ETFs. And actively managed ETFs come with a higher expense ratio.
- LOCK-IN PERIOD: ETFs do not have any minimum holding period. So the investors are free to sell the investment whenever they wish. Mutual Funds like ELSS (Equity Linked Saving Scheme) has 3 years lock-in period. During this time period, liquidating the investment is impossible. Depending on the chosen Mutual Fund scheme, the time period range from 9 days to 3 years.
HOW TO DECIDE BETWEEN MUTUAL FUNDS AND ETFs?
Both ETFs and Mutual Funds provide you with an exemplary and efficient way to build a diversified investment portfolio. For choosing the most compatible option you should be analyzing some of the factors:
- Ease to liquidate the investment
- How much risk you are willing to take?
- How much investment can you make?
- Your tax-saving strategy
- Your financial goals
You can narrow down your choice after answering these questions. ETFs provide you both more returns and flexibility in the short-run while Mutual Funds require you to invest for a longer time but it also helps to create a corpus for the future. After carefully considering the two options you can make a good decision. Also, visit our website “Wealthbucket.in”, and for further queries, just give a ring at +91 8750005655. or shoot on our email at firstname.lastname@example.org.