ETFs vs Mutual Funds: Which is the best market-beating strategy in current times?

There has been a buzz about investing in ETFs. I want to invest Rs 2-3 lakhs in the markets now. Should I go for stocks, ETFs or traditional mutual funds? Please guide.

Samantha D., Kolkata
 
Reply by Amar Ranu, Head - Investment Products & Insights, Anand Rathi Shares and Stock Brokers

An exchange-traded fund (ETF) is a type of investment vehicle that combines a collection of securities, such as stocks or bonds, into a single fund. ETFs are designed to track the performance of a particular index, sector, commodity, or asset class. One key advantage of an ETF is that it can be bought and sold on a stock exchange, similar to an individual stock. This gives investors the flexibility to trade ETFs throughout the trading day at market prices.

Mutual funds are investment vehicles that are traded only once per day, typically after the market closes, at the fund's Net Asset Value (NAV). This means that investors can buy or sell mutual fund shares at a price that reflects the total value of the fund's assets divided by the number of shares outstanding. The NAV is calculated at the end of each trading day based on the closing prices of the fund's underlying investments.

ETFs are flexible and inexpensive, but if you choose your actively managed mutual funds wisely, they provide alpha, or returns above the market. When compared to passively managed exchange-traded funds (ETFs), skilled fund managers are better able to spot discounted assets and timing investments. The cost of this potential is higher, though, so it's critical to select funds with seasoned management teams and solid track records.

We can say actively managed mutual funds could be a better choice if you want expert management and higher potential returns over the benchmark. ETFs are a good option if you want greater flexibility and benchmark returns.

In India, investors can benefit from a variety of advantages offered by both Exchange-Traded Funds (ETFs) and Mutual Funds. The choice between these two investment options depends on individual preferences and investment goals. ETFs are known for their lower costs and diversification benefits, while Mutual Funds cover a range of asset classes and offer the potential for tax-free gains over the long term.

Here are the major differences between ETFs and Mutual Funds

When it comes to how they are bought and sold, Exchange-Traded Funds (ETFs) and Mutual Funds have distinct differences. ETFs, similar to shares, can be actively traded on exchanges, providing investors with the flexibility to buy and sell at their convenience. In contrast, units of Mutual Funds are typically purchased directly from a fund house, although they may also be listed on exchanges.

ETFs do not have a minimum lock-in period, allowing investors the freedom to trade without restrictions. On the other hand, Mutual Fund units often come with a minimum lock-in period, and selling them prematurely can result in penalties.

Another key difference is that Mutual Funds are actively managed by professionals, whereas ETFs are passive investments that simply track index performance.

Indices and assets

ETFs typically track indices like the Nifty 50 or BSE Sensex, giving exposure to various companies across different sectors.

In comparison, Mutual Funds provide access to a range of asset classes such as equity, debt, and hybrid options. A key difference between ETFs and Mutual Funds is the taxation of gains. Short-term gains on Mutual Funds (invested for less than one year) are taxed at a higher rate than ETFs. On the other hand, gains from Mutual Funds held for over a year are tax-free, while ETF gains held for more than a year are subject to a lower tax rate than Mutual Funds.