Mutual Fund and ETFS for New Investors

What is mutual fund?

Mutual funds are pooled investments. When an asset management company (AMC) or fund house launches a new fund offer, it invites subscriptions from a large number of investors. Investors are allotted units at par value (usually Rs 10). So if you had invested Rs 10,000 in a mutual fund scheme during the NFO period, you would be allotted 1,000 units. At the end of the NFO period, the money pooled from different investors are invested in a diversified portfolio of securities (e.g. stocks, bonds, money market instruments etc) and managed by a professional fund manager as per the investment mandate of the scheme.

What is ETF?

ETF or exchange traded funds are passive mutual fund schemes which are traded on stock exchanges. You need Demat and trading account to invest in ETFs. Unlike actively managed mutual funds, ETFs do not aim to beat the benchmark index, they simply track the index.

Buying and Selling Units Mutual Funds and ETFs

Mutual fund units can be bought or sold (redeemed) to the AMC either directly or through a mutual fund distributor. Net Asset Value or NAV is the price at which you can buy or sell (redeem) units of a mutual fund scheme. NAVs of mutual fund schemes are calculated at the end of each business day, based on the closing prices of the securities in the scheme.

After the NFO period, ETF units can be bought or sold only through stock exchanges, unless you are transacting in lot sizes (creation unit) as specified by the AMC. Unlike mutual funds, ETFs are bought and sold in stock exchanges at bid / ask prices just like shares of companies. Buy / sell prices of an ETF can differ from the NAV of the ETF.

Expenses of Mutual Funds and ETFs

Total expense ratio (TER) of a mutual fund scheme is the cost of managing and operating the scheme on a per unit basis. It is calculated by dividing the total expenses of the fund with the assets under management (AUM). TER is deducted from the schemes assets (per unit) to arrive at the NAV of the scheme – it has a direct bearing on returns. Different mutual fund schemes have different TERs. You should know that TERs of ETFs are much lower than actively managed mutual funds.

Systematic Investment Plan

Systematic Investment Plan or SIP is a mutual fund facility through which you can invest fixed amounts every month (or any other interval) in a mutual fund scheme. Almost all mutual funds offer the SIP facility. However, this facility is not available for ETFs. Some stockbrokers may offer “SIP like” facilities for investing in shares and ETFs; you should check with your stockbroker.

Index Funds

Both mutual funds and ETFs have their advantages. While ETFs enjoy the benefits of lower risk and expenses compared to mutual funds, mutual funds offer a lot of convenience to retail investors. If you want to enjoy some of the benefits of ETFs, without forgoing the convenience of mutual funds, you can invest in Index Funds. Index funds are passive mutual fund schemes which track benchmark index like ETFs. Index funds are like ordinary mutual fund schemes in all other respects. You can buy / sell index fund units from / to the AMC and invest through SIP like other mutual funds.

In this article, we have discussed the main differences between mutual fund and ETF. Both are good investment options. You should discuss with your financial advisor and make informed investment decision based on what is most suitable for you.