ETFs vs Mutual Funds: Understanding the Key Differences

While the most notable difference is that ETFs can be bought through brokerages and not via fund management organizations like mutual funds, further distinctions in terms of ETF vs mutual fund also exist that we will cover in depth below.

 

 

What is an ETF?

 

Exchange Traded Funds (ETFs) refer to a group of securities that track an underlying index. Their functioning is similar to that of mutual funds in that you can invest in a group of instruments through a single fund. With these funds, you can invest in instruments like bonds, stocks, and commodities. These are traded on the stock exchange, meaning that their prices keep fluctuating throughout the day. This, in turn, ensures high liquidity.

 

When we compare mutual fund to ETF, it’s interesting to know that ETFs can be transferred, sold, or bought easily on a daily basis.

 

Some essential highlights of ETFs -

 

• Easy and quick purchasing and selling
• No investment restriction, allowing for as little as one share
• Real-time transactions
• Minimal broker commissions

 

 

Why Should You Invest in ETFs?

 

Let’s understand the benefits of investing in ETFs -

 

• Worldwide market reach: You can easily access multiple markets across the world as popular ETFs track various indices — DFMGI, Nifty 50, S&P 500, and more.
• Lower management costs: Compared to other investment instruments like mutual funds that offer similar diversification, the management fees and per unit costs of having ETFs are usually lower.
• Diversification: With ETFs, you can invest in different types of securities, which can lower the overall risk. This makes them a good choice for beginners.

 

Key Points Related to ETFs

 

While ETFs are popular investment sources, it’s necessary to understand a few points before investing in them -

 

1- Trading ETFs

 

ETFs are purchased and sold just like stocks. Consequently, they are also subject to the same criteria of the market where the investment is listed. ETFs trade on the exchange’s business days and operating hours.

 

2- Diversification

 

Investing in a unit of an ETF gives you exposure to numerous firms. For instance, when you purchase one unit of an ETF that follows the S&P 500, you get ownership of all of the firms in that ETF’s portfolio. 

Different ETFs offer exposure to various firms, industry sectors, markets, and areas that meet your requirements.

 

Risks Associated with ETFs

 

• While ETFs are less volatile than individual stocks, they still hold considerable risk due to their association with the market. 
• You can face exchange rate risks associated with investing in ETFs denominated in a different currency than your home currency.
• The previous performance of investment products like ETFs is not an indicator of future performance — the value of your investments can dip as well. 
• The funds may be liable for periodic or general ‘low liquidity’, where you may not be able to sell the requisite number of units at the publicly stated price on the relevant market. In such cases, you may have to 
  • Sell them at a discount or 
  • May not be able to sell them at all

 

What is a Mutual Fund?

 

Before understanding the ETF mutual fund difference, let’s quickly cover what mutual funds are. Mutual funds pool money from different investors and invest in various instruments on their behalf.

When you invest in a mutual fund, you purchase a portion of the fund and its assets, which may include stocks, bonds, or a mix of the two. These funds allow you to access numerous assets at once, thereby effortlessly diversifying your investments.

Some mutual funds are passively managed and seek to replicate the performance of a certain index or group of assets such as the ADX General Index. Others are actively managed, which means that a professional fund manager constructs a stock portfolio with the goal of outperforming a benchmark.

Active Investing or Management: An investment strategy where investors attempt to earn higher returns than the market Passive Investing: An approach where investors aim to replicate the market’s performance — this is done by trying to mirror the holdings of a specific market index

Here are some of the major mutual fund categories -

 

• Bond funds: These funds invest in bonds — issued by the Government or corporations. Generally, bond funds are less riskier.
• Equity or stock funds: Such funds invest in equities on the stock market. They may focus on a market index, a specific theme or sector (such as dividend-paying stocks), or as per any other criteria.
• Hybrid funds: These mutual funds invest in both equities and bonds to help you achieve good returns without much risk. 
• Small, mid, and large-cap funds: Some mutual funds are based on the market capitalisation of companies. For instance, small cap mutual funds primarily invest in companies that have a small market cap and are usually in their growing stage. 

 

Based on trade, mutual funds can be further divided into -

 

• Open-ended mutual funds: These mutual funds can be purchased and traded throughout the year — you can add or sell units on all trading days.
• Close-ended mutual funds: Such funds can only be sold at a fixed maturity date.

 

 

Why Should You Invest in Mutual Funds?

 

Check out some major benefits that you can enjoy when you invest in mutual funds -

 

• Diversification: Instead of directly putting your money in stocks, you can spread your investment and the corresponding risk across multiple instruments. This lowers the investment risk while also enhancing your returns.
• Professional management: Mutual funds are managed professionally. So rather than painstakingly devising your strategy, you can simply leave the job to experts. This also makes mutual funds suitable for those new to investing.
• Option available for both lump sum and periodic investments: With mutual funds, you can take advantage of the market scenario by making a one-time investment or regularly put fixed sums in the market over time via Systematic Investment Plans (SIPs).

 

Important Points to Know About Mutual Funds

 

Here’s what you need to keep in mind while investing in mutual funds in the UAE -

 

Regulatory Changes from 1 April 2024

 

As per the new regulations brought by the UAE Securities and Commodities Authority (SCA), effective from 1st April 2024 -

• Promotion of foreign mutual funds is restricted to Private placement for Professional Investors with a minimum ticket size (as per the SCA)
• Public Offering is allowed only for Retail Investors with locally domiciled funds.

 

Professional Investor (PI) and Retail Investor Definitions

 

Professional Investor (PI)	Retail Investor (RI)
Possesses net assets worth AED 4 million or more	Does not fulfil the criteria of a Professional Investor
Has confirmed the status of PI classification	Meets the requirements of PI but chooses to be a Retail client
Expertise in investing, financial markets, and risk management	-

What is ETF vs Mutual Fund?

 

Here are the major ETF and mutual fund differences -

 

• Clarity of Information: ETFs are usually obligated by law to report facts about their holdings at least on a quarterly basis. Mutual funds, however, may not have such a mandate. So while you can find many ETFs posting holdings data regularly, most mutual funds opt not to do so — usually to safeguard their investment strategy (trade secret).  
• Requirement for Minimum Investment: Mutual funds often require a minimum investment to start operations. ETFs, on the other hand, allow you to invest in as little as one share or only a portion of a share. 
• Way of Trading: While mutual funds are only available at the end of trading hours, ETFs can be purchased at any time throughout trading hours. This means you can liquidate your ETFs at any moment instead of waiting for trading to close for a day. 
• Principle of Investment: While around 80% of ETFs are passively managed, mutual funds are usually managed actively. This, in fact, is done by experts who can beat the returns of market indices.
• Costs: In the previous point, we saw that most mutual funds are actively managed. This, however, also brings higher management costs too. 

For instance, ETFs tend to report average annual fee ratios of around 0.2 to 0.3%. With mutual funds, however, this can go well beyond 1%, i.e. almost 4 times. 

 

 

ETFs vs Mutual Funds — Which One is Better?

 

Choosing between ETFs and mutual funds can certainly be a tough choice. With both investment options, you can create significant wealth over time while also diversifying your investments.

 

Here are some essential points regarding ETF mutual fund differences that you should remember before investing -

 

• Risk Tolerance - If you are fine with high risk for high reward, you can invest in mutual funds that aim to outperform market indices. However, if you want to minimise the risk, you can go with ETFs that seek to replicate mainstream indices.
• Financial Goals - For aggressive growth, you can go for options like small cap mutual funds. However, for stable returns without much risk, you can go for index funds’ ETFs.
• Frame and Timeline of Investment - If you’re looking for quick returns in the short term, you can go for mutual funds tailored to the same. In case your horizon is longer, you can choose ETFs related to market indices.
• Ease of Trading - For those looking to buy and sell units regularly, ETFs are the better option — these funds can be traded on the market just like your favourite stocks, 

 

However, if you want passive investment and want to purchase only once in a while, go with mutual funds. 

 

FAQs

 

 

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