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  • ETF vs. Mutual Funds

    Recently, there has been a lot of discussion around exchange-traded funds (ETFs) being one of the best investment channels. For the uninformed, these funds may seem like mutual funds as they pool together the money of investors to buy a portfolio of bonds and stocks that are diverse. So what exactly is the difference between the two?

    In fact, there is not much of a difference between ETFs and mutual funds. One of the main differences between the two is the fact that you can buy a share of ETF through a brokerage, like stocks, not through a fund management company that sells mutual funds.

    Most of the ETFs are managed like index funds, which essentially implies that dedicated managers do not choose the investments that will be held. Instead, these funds mimic a list of investments. The choice between a mutual fund and an ETF is based on the convenience of the buyer. If he/she already has a brokerage account it is very easy and convenient to buy an ETF. If an investor does not have a brokerage account, it is better to opt for a mutual fund instead.

    What is ETF?

    ETF or Exchange Traded Fund is an investment fund which is traded on the stock exchange. The assets held under an ETF are commodities, stocks and bonds. These are traded for an amount close to the original net asset value of the asset, during a trading day. A bond index or stock index is tracked by most ETFs. The price of the ETF can vary throughout the day. Generally, ETFs have lower fees and higher daily liquidity compared to mutual fund shares. ETF can be used for the following purposes: Hedging, Equitizing Cash and for Arbitrage.

    ETF shareholders get a part of the profits, i.e, the dividends paid and interest earned. They may also get a residual value if there is a liquidation of the fund. ETF shares are usually traded on public stock exchanges, so these shares can be transferred, bought, or sold easily like the shares of a stock.

    ETF supply is regulated through “creation” and “redemption” processes that involve some special investors, also referred to as authorised participants (APs). APs are usually renowned financial institutions such as banks and investment firms that have a great deal of buying power.

    The key advantages of ETFs are as follows:

    • Investors can sell short or buy on margin. They can also purchase one share, as there are no minimum investment requirements.
    • The commission that is paid to the broker when buying or selling ETFs is the same as that paid for a regular order.
    • It is comparable to a mutual fund that can be bought and sold at a cost that varies throughout the day. The transactions are carried out in real-time as well.

    What are Mutual Funds?

    Mutual Funds are a professionally managed investment funds that trades in diversified holdings. Funds are pooled from various investors and invested with the assistance of professionals. The investment portfolio includes bonds, money market instruments, stocks or a combination of all. The investor owns a share of the mutual fund and reap the same benefits or losses as the other shareholders.

    ETF shareholders get a part of the profits, i.e, the dividends paid and interest earned. They may also get a residual value if there is a liquidation of the fund. ETF shares are usually traded on public stock exchanges, so these shares can be transferred, bought, or sold easily like the shares of a stock.

    ETF supply is regulated through “creation” and “redemption” processes that involve some special investors, also referred to as authorised participants (APs). APs are usually renowned financial institutions such as banks and investment firms that have a great deal of buying power.

    The key advantages of ETFs are as follows:

    • Investors can sell short or buy on margin. They can also purchase one share, as there are no minimum investment requirements.
    • The commission that is paid to the broker when buying or selling ETFs is the same as that paid for a regular order.
    • It is comparable to a mutual fund that can be bought and sold at a cost that varies throughout the day. The transactions are carried out in real-time as well.

    What is the difference between an ETF and a Mutual Fund?

    Mutual Funds Exchange Traded Fund (ETF)
    Mutual Funds are traded at the closing net asset value. Exchange Traded Funds are traded during the course of a trading day and its value varies during this time.
    Mutual Funds have varying operating expenses. ETF has lower operating expenses.
    Most Mutual Funds have a minimum expense specified. There is no minimum investment specified for Exchange Traded Funds.
    Mutual Funds have more tax liabilities than ETFs. ETFs offer tax benefits to the investors due to the manner of its creation and redemption.
    Mutual Fund shares can only be purchased directly from the funds at the NAV price that is fixed during the trading day. ETF can be bought and sold anytime on the stock exchange, at the prevailing market price.
    Generally, compared to ETFs, the transaction costs are zero when mutual fund shares are bought or sold. There is an additional cost involved while trading ETFs, which is called the “bid-ask spread”.
    Mutual Funds have lower liquidity compared to Exchange Traded Funds. ETF has higher liquidity since it is not connected to its daily trading volume. ETF liquidity is related to the liquidity of the stocks included in the index.
    Some mutual funds levy a penalty on selling the share early. Usually, the time limit imposed on selling a share is 90 days from the date of purchase. ETF do not have a time limit on selling an asset. The investor can buy or sell at any point of the trading day at the price available during the time. Therefore, there is no minimum holding period specified for the same.
    Mutual Funds are index-tracking but is actively managed by professionals. Assets are picked in such a way that it beats the index and achieves higher performance. Exchange Traded Funds track an index, i.e., it tries to match the price movements and returns indicated in an index by assembling a portfolio which is similar to the index constituents.

    GST rate of 18% applicable for all financial services effective July 1, 2017.

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