ETFs and mutual funds may look similar at first glance; both pool investors’ money and offer diversification, but they work very differently when it comes to trading, costs, and flexibility.
In this blog, we’ll break down the key differences between ETFs and mutual funds, explain how each works, and help you decide which option fits your investing goals best.
Introduction to ETFs and Mutual Funds
ETFs (Exchange-Traded Funds) and mutual funds are two of the most popular investment options for creating wealth and achieving financial goals in the long term.
What Are ETFs?
ETFs are investment funds that track an index, sector, or basket of assets, such as the Nifty 50 or the S&P 500.
Key Features of ETFs:
- Traded on Stock Exchanges: You can buy or sell ETFs during the trading day at market rates, just like stocks.
- Passive Management: Most ETFs aim to replicate an index rather than beat it, resulting in lower management costs.
- Transparency: ETF holdings are publicly disclosed daily, allowing investors to see exactly what they own.
What Are Mutual Funds?
Mutual funds pool funds from many investors to invest in a diversified portfolio of assets (stocks, government bonds, or money market instruments), depending on the fund’s objective.
Key Features of Mutual Funds:
- Fund managers make investment decisions for investors.
- Mutual fund units are bought or sold at the NAV (Net Asset Value), which is calculated once daily.
- Let’s investors invest small amounts regularly, encouraging discipline and consistency.
Key Differences Between ETFs and Mutual Funds
While both ETFs and mutual funds help investors diversify and grow their wealth, they differ in how they’re traded, managed, and priced.
ETFs vs Mutual Funds: Trading and Liquidity
ETFs are traded on stock exchanges for the entire trading day, just like individual stocks. Their prices fluctuate in real time based on market demand and supply. This allows investors to purchase or sell ETF units at any time during trading hours at the prevailing market price.
Mutual funds, on the other hand, do not trade on exchanges. They are bought or sold only once a day—after the market closes—at the NAV determined for that day. This means you don’t know the exact price of your purchase or redemption until the day’s NAV is announced.
Fees: ETF vs Mutual Fund
ETFs typically have lower expense ratios because most are passively managed, tracking an index rather than trying to outperform it. However, investors might pay brokerage or transaction fees when buying or selling ETFs.
Mutual funds usually have higher management fees, especially if they are actively managed by fund managers who make investment decisions. They may also include exit loads if you redeem units early, and some platforms may charge transaction or advisory fees.
Flexibility: How Are ETFs and Mutual Funds Different?
ETFs provide maximum flexibility, allowing investors to buy, sell, or even short-sell units at any time during market hours. You can also set limit or stop-loss orders, just like with regular stock trades. This makes ETFs ideal for both short-term traders and long-term investors.
In contrast, mutual funds are better suited for investors who prefer a hands-off approach. You can’t trade during the day, but you can invest systematically through SIPs or lump-sum investments without constantly monitoring the market.
Advantages and Disadvantages of ETFs and Mutual Funds
Below is a clear breakdown of their pros and cons to help you decide.
Advantages of ETFs
- ETFs typically have low expense ratios since most are passively managed and track an index rather than trying to beat it.
- ETFs trade on stock exchanges, allowing you to buy or sell anytime during market hours at real-time prices.
- ETFs are structured to minimise capital gains taxes, as shares are exchanged on the secondary market rather than redeemed directly by the fund.
- ETF holdings are disclosed daily, giving investors a clear view of what’s inside the fund.
Advantages of Mutual Funds
- Mutual funds are overseen by professional fund managers who handle asset allocation, research, and portfolio decisions.
- SIPs make it easy to invest regularly without worrying about market timing.
- Available across multiple categories (equity, debt, hybrid, and index funds), suiting different investor profiles.
Disadvantages of ETFs
- Since ETFs are traded on exchanges, you’ll incur brokerage and transaction fees with each buy or sell order.
- You must have a brokerage and Demat account to invest in ETFs, which adds to setup and maintenance requirements.
- Since ETFs trade throughout the day, prices can fluctuate sharply, which might tempt impulsive decisions.
Disadvantages of Mutual Funds
- Actively managed mutual funds usually have higher expense ratios, which can lower your long-term returns.
- Mutual fund transactions are processed only once a day at NAV, meaning no intraday trading opportunities.
- Some funds charge an exit load if you redeem units before a specified period, which lowers your net gains.
When to Choose ETFs and When to Choose Mutual Funds
Both ETFs and mutual funds are strong investment options, but the right choice depends on your investment style, time horizon, and goals.
Choosing ETFs for Active Traders
Some reasons why ETFs work for active traders are:
- You can buy or sell ETF units anytime during market hours at live prices, just like stocks.
- Most ETFs have low expense ratios, which make them cost-efficient for investors who value fees and tax savings.
- ETF holdings are disclosed daily, which allow traders to make informed, timely decisions.
Choosing Mutual Funds for Long-Term Investors
Some reasons why mutual funds work for long-term investors:
- Fund managers actively manage portfolios, selecting securities to achieve optimal returns over time.
- SIPs encourage consistent contributions and help investors benefit from rupee cost averaging.
- Dividends and gains are automatically reinvested, which improves long-term growth potential.
Conclusion
Both ETFs and mutual funds have the same purpose—helping investors build diversified portfolios. But they cater to different investing styles.
ETFs offer flexibility, lower costs, and real-time trading, which make them ideal for investors who want control and actively manage their portfolios. On the other hand, mutual funds give professional management, and ease of investing, making them perfect for those who prefer a hands-off, disciplined approach.
Basically, the right choice depends on your financial goals, risk tolerance, and level of involvement. Many investors even combine both—using ETFs for short-term tactical exposure and mutual funds for long-term wealth creation.
Frequently Asked Questions (FAQs)
What is the 70/30 rule ETF?
The 70/30 rule ETF typically refers to a portfolio allocation strategy where 70% of the investment is placed in equities (stocks) and 30% in bonds or fixed-income assets. This mix helps balance growth potential with stability, offering diversification and smoother long-term returns.
Why might an investor choose an ETF over a mutual fund?
Investors often prefer ETFs (Exchange-Traded Funds) because they:
- Trade on stock exchanges like shares, offering real-time pricing.
- Provide greater flexibility for buying and selling throughout the day.
- They are generally more tax-efficient due to their structure.
What is the 3:5-10 rule for ETF?
The 3:5-10 rule is a simple diversification guideline suggesting that:
- You should own at least 3 ETFs for basic diversification,
- 5 ETFs for moderate diversification, and
- 10 ETFs for a well-balanced, global portfolio.
What is the 7/5/3-1 rule in mutual funds?
The 7/5/3-1 rule outlines expected returns from different types of investments:
- 7% from debt funds,
- 5% from balanced or hybrid funds,
- 3% from savings instruments, and
- 1% as a margin of safety or possible variation.
Should I switch my mutual funds to ETFs?
Switching from mutual funds to ETFs depends on your investment style and goals:
- Choose ETFs for low-cost, flexible, transparent investing.
- Stick with mutual funds if you prefer SIPs, automatic reinvestment, and active management.
What is the 80% rule for mutual funds?
The 80% rule requires that a mutual fund invest at least 80% of its assets in securities that align with its stated investment objective. For example, a large-cap equity fund must keep at least 80% of its portfolio in large-cap stocks.
Is it safe to invest 20 lakhs in mutual funds?
Yes, investing ₹20 lakhs in mutual funds can be safe if done wisely. The key is diversification and goal alignment:
- Divide the amount across equity, debt, and hybrid funds based on your risk profile.
- Choose SIPs or staggered investments instead of a lump sum to manage market volatility.
- Select funds with a good past track record and strong Sharpe or Sortino Ratios.
Disclaimer
The information provided in this article is for educational and informational purposes only. It should not be considered as financial or investment advice. Investing in stocks involves risk, and it is important to conduct your research and consult with a qualified financial advisor before making any investment decisions. The author and publisher are not responsible for any financial losses or gains that may result from the use of this information.
