Is There A Difference Between ETF and Mutual Fund?
Updated on 23 Mar 2020
We’ve all heard the terms – ETF and Mutual Funds. They sound similar, but they are not. Let’s look at the differences between ETF and Mutual Fund in this article.
ETF vs Mutual Fund – The Debate
On paper, ETFs and Mutual funds may across as the same thing. Exchange Traded Funds are securities that track an underlying index, mapping the performance of the same. Mutual funds do this too. Both function under the same regulations set in place regarding the amount that can be concentrated in a holding, what they can own, the funds that can be borrowed based on the size of the portfolio. However, that’s where the similarities end. There are a few nuanced differences that set the two apart, and identifying these can help you make the right investment choices between ETF vs mutual fund.
The following are the main differences between ETF and mutual fund:
There are differences in the way they trade!
When you invest in a mutual fund, you must keep in mind that whether you want to buy or sell these, you must pay attention to the Net Asset Value (NAV). This may fluctuate throughout the day but often settles on a number at the end of the day, when the market opens for trading. Hence, mutual funds can only be traded at the end of the day. Do keep in mind that if any stocks or prices experience dips or highs throughout the day, you have no control over the final trade or its execution. It is a matter of being happy with the cards that you are dealt with.
On the other hand, ETFs trade intraday and there is no set timing for them the way there is one for mutual funds. As the prices of these funds fluctuate throughout the day, investors that want to time the market and take advantage of price movements will find themselves gravitating more towards ETFs than mutual funds. However, do keep in mind that you must be willing to follow an active investment strategy if you want to time the market.
There are differences in the expense ratios!
Mutual funds require active management and as most investors balk at the thought of managing the funds themselves, companies hire fund managers to do the same. As a result of this, the expense ratio associated with mutual funds is often on the higher side, making it harder for younger investors to grow their wealth by starting out with this financial product.
ETFs, on the other hand, have a much lower expense ratio associated with them, which is what makes them a great investment option for investors of all walks of life.
There are differences in your tax liability!
Whether you invest in mutual funds or ETFs, you have to pay taxes if you end up selling their shares for a profit. Depending on the situation at hand, you may have to pay either long term or short term capital gains tax which may end up eating into your earnings. This is where the distinction between mutual funds and ETFs can help you.
Mutual funds generally have a higher tax applicable on them. This is because investors get capital gains distributions from them, which are basically taxable. However, this does not apply to ETFs as they do not pay their investors with capital gains distributions. Of course, if you already hold your investments in certain tax-advantaged vehicles such as the 401 (k), this advantage disappears. Any money that you deposit in them is not subjected to income tax, as long as it falls within the yearly limits. Additionally, even when you make a trade on your investments, they still remain tax-free, which works really very for investors looking to cut down on their overall taxes.
There are differences in their fees!
Finally, another thing to keep in mind is that the fees for mutual funds and ETFs tend to differ too. ETFs do not have any sales load fees that you need to worry about. At times, you might find that you need to pay a commission when making a sale, but this is generally a rarity. Most ETFs tend to trade for free, which again makes them more accessible to investors from all walks of life. Unfortunately, the same cannot be said for Mutual Funds. The fees that you may have to pay for them can vary from fund to fund.
ETF versus Mutual Funds – The Bottomline
Now that you know the basic difference between ETF and mutual fund, you’re one step closer to trading in them and growing your wealth. All you need to do now is identify your investment goals, risk appetite, need for diversification, apt term period, and of course, the right fund for all your needs. Sounds like a daunting challenge? Don’t worry!
Our expert advisors at Kristal AI review AI recommended suggestions for the top India ETFs and Global ETFs based on your needs and then help you grow your funds. If you want to watch all your dreams come true, get in touch with us today.
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