Difference between Exchange Traded Funds & Mutual Funds

If you haven't yet started investing and feel that savings alone will suffice you in the long run, you are wrong. Although saving is a good habit which each and every individual should inculcate, saving alone may not be able to help you beat inflation. If you want to increase your chances of creating wealth you may have to invest in a few investment schemes. But before investing in any scheme, make sure that you have a financial planning charted out. Financial planning is nothing but giving your investments a direction so that you are able to prioritize your financial goals and save enough so that you can regularly invest and achieve your goals.

The first step of financial planning is jotting down your short term and long term financial goals. When you set realistic goals, investing may become a lot easier as you now have a fair idea about how much and in which schemes to invest in order to achieve those goals. Also, prioritizing your goals is essential as you cannot target all financial goals at a time. If you have long term goals like building a retirement corpus, you will have to invest for at least 25 to 30 years regularly in order to achieve that goal. On the other hand, short term and medium term goals like buying a car or renovating your home may need you to find a scheme that suits an investment horizon of three to five years.

Just like setting realistic financial goals is important, knowing your risk appetite is essential too. A risk appetite is an individual’s ability to take a certain amount of risk to invest in a scheme to seek potential gains. If you are someone with zero risk appetite, you may want to stick to conservative investment avenues. However, these investment schemes offer low fixed interest rates and may or may not help you reach your goals. However, if you do not mind taking some risk and invest in avenues that offer high risk rewards ratio, you may consider investing in mutual funds.

What is a mutual fund?

Mutual funds are professionally managed pools of funds where fund houses and AMCs collect money from investors sharing a common investment objective and invest this money collectively across the Indian economy is assets like equity, debt, call money, corporate bonds, etc.

SEBI, the regulatory body of mutual funds in India describe them as, “a mechanism for pooling the resources by issuing units to the investors and investing funds in securities in accordance with objectives as disclosed in the offer document. Investments in securities are spread across a wide cross-section of industries and sectors and thus the risk is reduced. Diversification reduces the risk because all stocks may not move in the same direction in the same proportion at the same time. Mutual fund issues units to the investors in accordance with the quantum of money invested by them. Investors of mutual funds are known as unitholders.”

What are exchange traded funds?

Securities and Exchange Board of India (SEBI) defines ETFs as “is an open ended scheme which replicates/tracks the particular index. Of the total assets, this fund must invest a minimum of 95 per cent in securities of a particular index (which is being replicated or tracked)”.

To simplify, an exchange traded fund (ETF) follows a particular index, for example, the NIFTY 50 or S&P 500 Index. Exchange traded funds do not involve the active participation of the fund manager. Exchanged traded funds are marketable security which can be traded at the exchange just like any other company stock.

Difference between mutual funds and exchange traded funds

Now that you know the difference between ETFs and mutual funds, where are you going to invest? Irrespective of what investment vehicle you choose, make sure to do some background check about the fund before investing. And if you are completely new to investing, do seek some professional help.

Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.