In short, an ETF or Exchange-Traded Fund is an investment fund that combines the best features of mutual funds with the simplistic idea of exchanging equities on the stock market.

Picture this: You are in a marketplace where, instead of individual stocks or commodities, entire portfolios (or their shares) are packaged into a single, tradable security.

Voila! That’s an ETF.

ETFs offer their investors the convenience of buying and selling a whole “basket” of assets of a certain category, which may include equity ETF, bonds ETF, or commodity ETF, in one single transaction — just like you would with individual shares.

Since these funds track market indexes like the Nifty 50 or BSE Sensex, they also reflect the market’s true status.

Now, one question arises — “Where should I invest my money?”

Traditionally, a lot of investors in India are usually partial to investment options such as Fixed Deposits (FDs), Gold, Savings Accounts, and physical Real Estate. But with India’s recent education and investment boom, investors’ participation in other investment categories is growing, especially in equities, listed bonds, mutual funds, and alternative investment opportunities, like unlisted bonds, asset leasing, real estate debt, venture debt, etc.

To evaluate whether  ETFs and mutual funds are the best investment options, you must first understand how they can impact your financial portfolio in the long term.

How Do ETFs Differ From Mutual Funds?

While ETFs and mutual funds share similar traits, i.e., distributing investors’ money to purchase a diverse range of securities, there are still many things that set them apart. They are as follows:

Trading Flexibility

ETFs are traded throughout the day, much like individual stocks, with their prices fluctuating based on supply and demand. You can buy or sell ETFs anytime within trading hours at the market price.

But mutual funds are only traded once a day after the market closes. The NAV (Net Asset Value), calculated at the end of each trading day, determines the price at which you can buy or sell mutual fund units.

Initial Investments

Generally, ETFs have lower initial investment requirements than mutual funds. You can simply buy an ETF for the cost of one share, which could be significantly lower than the minimum investment required for any mutual fund. That makes ETFs a more manageable investment option, especially for novice investors or those with limited capital.

Fees

“Active” funds, like mutual funds, have a fund manager deciding what securities to buy or sell to outperform the market. But passive funds, such as ETFs, simply track a specific index, sector, or commodity. Some ETFs are, however, actively managed, too, but they are rare.

As a result, typically, ETFs have lower expense ratios – or how much you have to pay over the course of a year to own the fund – compared to mutual funds. However, you may have to pay a brokerage fee every time you trade an ETF — just like you would with a stock. On the other hand, mutual funds, particularly those that are actively managed, tend to have higher expense ratios.

Transparency

When it comes to transparency, ETFs score higher. They disclose their holdings daily, allowing investors to know exactly what assets they own at any given time. But that’s not the case with mutual funds, which usually disclose their holdings once every four or six months.

Are ETFs A Better Investment Choice Than Mutual Funds?

Not necessarily!

While both ETFs and mutual funds offer ways to diversify your portfolio, there are certain advantages and disadvantages to both categories.

Let’s elaborate…

What Works In Favour Of ETFs

Flexibility In Trading

One of the most attractive features of ETFs is that you can trade them like regular stocks. You can buy or sell ETFs anytime at fluctuating market prices.

Mutual funds, on the other hand, can only be traded once a day – after the market has closed.

Lower Costs

In the world of investments, every rupee counts!

And as we already explained, ETFs usually have lower expense ratios. In other words, it will likely be cheaper for you to own ETFs than mutual funds. That can significantly impact your portfolio’s long-term growth as these savings can also compound over time.

Diversification Of Your Portfolio

When it comes to investing, no one can see impressive results without diversifying their portfolio. And this is where ETFs become particularly handy within an asset class, say equity or bonds.

Let’s say that the ETF you have purchased is tracking the Nifty 50 index, which tracks the performance of the top 50 Indian companies listed on the NSE.

Then, instead of building a portfolio on your own by purchasing stocks from, let’s say, Airtel and a few other companies to diversify, you can now spread out your investments more easily — as well as the accompanying risks because you would now own chunks of all the top names in the banking, technology, or energy sectors in India.

So, from tracking a specific industry, commodity, or broad-market index to giving exposure to nearly any niche market around the globe, ETFs can help minimize risk and increase the net returns of your portfolio in comparison to building an equity or bond portfolio with different companies. 

Flexible Dividend Payouts

With ETFs, you can either reinvest the dividends you receive or cash them out directly. This flexibility can make all the difference, depending on your financial situation and goals.

Are There Any Downsides To Opting For ETFs Over Mutual Funds?

While ETFs have been garnering a lot of attention due to their potential benefits, every coin has two sides. So, before you rush to invest your money in ETFs, you must be aware of what the downsides are.

Trading Costs

Although ETFs typically have lower expense ratios than mutual funds, you’ll likely incur a brokerage charge every time you trade an ETF. These costs can add up, especially if you’re an active trader or want to invest small amounts regularly.

Premiums Or Discounts

It’s possible that you would have to buy an ETF for more than its actual worth or sell it for less than its true value. This usually happens due to supply-demand dynamics, especially with less liquid or thinly traded ETFs.

Complexity

Some types of ETFs, like leveraged or inverse ETFs, can be complex and carry additional risks. The former is designed to provide a significantly higher yield than its regular counterpart, whereas the latter ‌is meant for short-term trading.

Nonetheless, because of these facets, such ETFs can also be much riskier than traditional ETFs.

Dividend Payout Delay

Although investors do earn dividends from ETFs, there can be a delay in passing these gains on to them. This lag can have an impact ‌‌on total returns and may cause some issues, particularly for those who view these payouts as additional income.

Who Should Invest In ETFs?

Are you unsure about whether you should include ETFs as part of your investment strategy? If you fall under any of the following categories, it may be a wise idea to add ETFs to your portfolio.

Active Traders

For those who prefer to buy and sell securities throughout the day, ETFs can be a good choice. The prices fluctuate from time to time, allowing investors to take advantage of intra-day price movements.

Note: Even though you might find ETFs’ typically lower expense ratios appealing, do account for applicable brokerage fees (when you buy or sell).

Investors Looking For Flexibility

If you want flexibility and more control over your investments, then ETFs can offer a distinct advantage. You can use advanced trading techniques like short selling or buying on margin to maximise your profits.

Niche Investors

If you’re looking to invest in a specific sector, commodity, or market, ETFs can offer targeted exposure (and less risk) that might be harder to achieve with mutual funds. ETFs can track everything from gold to technology stocks, so don’t let most niches scare you away from investing.

While these investor profiles may benefit the most from investing in ETFs, it doesn’t mean others won’t. Investing in ETFs, mutual funds, or a combination of both should be guided by your financial goals, risk tolerance, investment horizon, and personal preferences.

Where Should I Invest In ETFs?

Here are some general avenues through which you can invest in ETFs, keeping your convenience and preferences in mind.

Stock Exchange

You can buy or sell ETFs during trading hours, and their prices fluctuate throughout the day based on supply and demand. You’ll need a Demat and trading account to invest in ETFs through a stock exchange.

Online Brokers

Many investors prefer using online brokers to buy and sell ETFs. Online brokers offer convenient and easy-to-use platforms for trading; they also frequently provide research tools, educational materials, and customer support.

Direct Investment Plans

Some ETF providers offer direct investment plans that allow you to invest in ETFs on a systematic, scheduled basis. This can be an excellent option for investors looking at a more passive, long-term investment strategy.

The Final Takeaway

The choice between ETFs and mutual funds shouldn’t be an “either-or” decision. You need to understand what suits you best, depending on things like your current financial strengths and your risk “appetite.”

But always remember that a well-diversified portfolio is key to financial success, so be wise and do your research before you purchase either option.

If you’re interested in more investment opportunities in India, keep following our blog for regular updates.