What is ETF, How it is different from Mutual Funds?

What is ETF?

ETF refers to the security type which contains a different type of securities in it such as bonds, stocks, etc. that trades on the exchange like the stock and the price of which fluctuates many times in a day as and when the exchange-traded fund is bought and sold exchange.

• The investment objective is to mimic a similar return as that of a particular market index.
• ETF originates through a new fund offering (NFC) by an AMC.
• Investors exchange their portfolio and cash component in return for ETF units.
• NFO is limited to large institutional investors and other investors.
• ETF units are made up of two components- portfolio deposit and cash component.
• The NAV of an ETF is the value of all the components of the benchmark index, held by the ETF, plus all accrued dividends fewer management fees.

NAV= fair or market value of schemes + net current assets

Types of exchange-traded funds

1. Equity funds
2. Fixed income funds
3. Currency funds
4. Special funds

Equity funds-

Equity funds can be further classified as large-cap, small-cap, etc., sector-specific funds, index funds, etc. as the name suggests, the underlying in these funds is equity. the investigator gets the advantage of diversified investment with a small capital investment

Fixed income funds-

these funds offer lesser volatility, hence providing some degree of assured returns.

Currency funds-

the purpose of investing in currencies is to provide a hedge to exposure in local currency For example, having exposure in GBP may provide gains when the dollar depreciates in global markets.

Special funds-

foreign markets funds, derivative funds, inverse ETFs, leveraged funds are other complex structured funds that are sought by investors having specific requirements. Although a little was less liquid than the conventional ETFs, these funds are held by corporates to hedge exposure/ invest in markets specific to their business.

Advantages of (ETF) Exchange-traded fund

• Low expense ratio: most of the ETFs are passive funds i.e., these funds mimic the performance of indexes. This results in a lower expense ratio i.e., lower funds management cost, sales, etc.
• Taxes: lesser transaction tax. Also, ETFs result in lower capital gains, therefore the lower capital gains taxes.
• Traded all day: exchange-traded funds are traded throughout the day, hence providing day trading opportunities for a scalp trader and bringing in all the possible combinations of stop orders, etc.

Disadvantages of (ETF) Exchange-traded fund

• Expensive- if diversification is not the priority, the cost of investing in ETFs will not be noticeably higher than investing directly in stocks.
• Diversification- although, investment is diversified when compared to cherry-picking the stocks to invest. ETFs are less diversified when compared to mutual funds.

Mutual funds

What are mutual funds?

Mutual funds are a pool of money, invested by many investors. the fund is managed by experienced and expert professionals. This fund is set up in the form of trust. This trust has a sponsor, trustee, asset management company.

Ideally, your investment portfolio will include more than just mutual funds, mutual funds are a common way to start investing. You may have had to choose mutual fund investments for 401(k) or another retirement plan through your employer, but do you know what you’re investing in?

Each mutual fund invests in a variety of stocks, bonds, or other securities to meet a specific investment objective, such as income or growth.

Mutual funds make money in several ways;

• After selling securities.
• Interest in the investments it owns.
• Charging fees and operating costs to the customers.

Types of mutual funds

1. By maturity period;
2. Open-ended
3. Close-ended
4. By investment objective
5. Equity
6. Income
7. Balance fund
8. Money market
9. Gilt fund
10. Index fund

Advantages of mutual funds to the investors;

• Portfolio diversification
• Professional management
• Reduction in risk
• Reduced transaction costs
• Liquidity
• Economies of scale

Disadvantages of mutual funds to the investors;

• No control over portfolio
• Subject to market risk.
• No guarantee of returns
• Management fees
• Lock-in-period
• Over diversification
• Not for short-term
• Costs to manage the mutual fund
• Managing a portfolio of funds

Various mutual funds in India

• State bank of India mutual fund
• ICICI Prudential mutual fund
• Tata mutual funds
• Birla sun life mutual funds
• Reliance mutual fund
• Kotak Mahindra mutual fund etc.

The difference between ETFs and Mutual funds are;

ETF

• Exchange-traded funds are traded during a trading day and their value varies during this time.
• ETF has lower operating expenses.
• There is no minimum investment specified for exchange-traded funds.
• ETFs offer tax benefits to the investors due to the manner of their creation and redemption.
• ETFs can be bought and sold anytime on the stock exchange, at the prevailing market price.

Mutual funds

• These funds are traded at the closing net asset value.
• Mutual funds have varying operating expenses.
• Most mutual funds have a minimum expense specified.
• Mutual funds have more tax. Liabilities than ETFs.

Conclusion

In conclusion, After a deep study on the topic of what is ETF and how it is different from Mutual funds. It covers the objective which I have set ( complete information about ETFs and mutual funds, their types, how it works, their advantages and disadvantages.

 The main point of how ETFs are different from mutual funds. I have observed that ETFs are used by investors who want exposure in specific industries. They do have certain advantages over mutual funds. They may be attractive for investors with a shorter horizon and implement scalp trading strategies because of the all-day trading window.

 Whereas mutual funds offer good investment opportunities to the investors. like all investments, they also carry certain risks. The investors should compare the risks and expected yields after the adjustment of tax on various instruments while taking an investment decision. The investors may seek advice from experts and consultants including agents and distributors of mutual funds schemes while making investment decisions. This all information provides me proper knowledge of both funds.

You may refer to this video if you want the explanation in Hindi