ETF v/s Mutual Fund v/s Direct Mutual Fund5 min read
Making the decision to invest isn’t all that hard. The pros are many and the lure of financial freedom is hard to resist. But what do you do next? Where and how you want to invest your money is the next decision you need to make. While the options are plenty, not all of them will suit your unique situation and help you achieve your specific financial goals.
But let’s get to the point, shall we? Even if you’re new to the investment world you are probably familiar with mutual funds – surely, you’ve seen an ad or two – and they do come highly recommended for beginners. However, there’s also been a lot of talk about exchange-traded funds (ETFs) being one of the best investment instruments. And yes, there are other avenues to explore, but for the moment, let’s zoom in on these and understand them a little better.
What are Mutual Funds, Direct Mutual Funds and ETFs?
Mutual funds and ETFs are quite similar in that they are both baskets of different securities like stocks or bonds. However, there are some distinct differences in how they work.
ETFs are passively managed funds that replicate an index like the SENSEX or the Nifty50. These funds follow the performance trajectory of the index and do not have a fund manager to actively manage them. Furthermore, ETFs are actively traded on the stock exchange and can be freely bought or sold throughout the trading day.
Mutual funds on the other hand are professionally managed investment schemes that pool money from various investors and invest that in diversified holdings. These include a wide range of securities like stocks, bonds, debt instruments and more. An investor owns a share of the mutual fund and is subject to the same gains or losses as the other shareholders.
But there’s more, besides regular mutual funds, you also have the option of Direct Mutual Funds. They are the same as actively managed funds, but with the autonomy to select and handle the fund lying directly with the investors themselves (or with a direct mutual fund platform). If you are willing to take the responsibility of selecting the fund, you can avoid paying the commission.
Choosing your investment instrument
Choosing the right investment instrument will ultimately depend on your approach to risk and financial goals. But to help with that, let’s compare the three a bit more.
1. Expense ratio:
As per the regulations of the Securities and Exchange Board of India (SEBI), the maximum expense ratio that can be charged by a mutual fund house for a scheme is: up to 2.25% for equity-oriented schemes, up to 2% for debt-oriented schemes and up to 1.5% for index funds and ETFs.
However, some mutual fund houses charge a lower expense ratio than the maximum permissible limit, particularly for direct plans and index funds/ETFs. The expense ratio for direct mutual funds can range from 0.10% to 1.50%, while that for ETFs can range from 0.05% to 1.00%. On the other hand, the expense ratio for regular mutual funds can range from 1.50% to 3.00%, including distributor commissions and other expenses.
2. Additional Expenses:
Investing in ETFs requires a Demat account which incurs an annual maintenance fee, albeit often nominal. There are also implicit costs resulting from buying or selling an ETF – this price can differ from the value of the underlying holding. Mutual funds, on the other hand, do not incur these costs, they may however incur an exit fee if you decide to exit the fund before the lock-in period is over.
Regular mutual funds are actively managed by fund managers, who are well-versed with the market and offer advice and guidance when needed. Direct mutual funds are usually recommended for those who have a grasp on the market as they need to make decisions without the assistance of an intermediary. ETFs however, simply track the performance of the market index.
ETFs and direct mutual funds can be bought and sold online through the fund house’s website or through various online platforms. In contrast, regular mutual funds require investors to go through intermediaries such as brokers, financial advisors, or distributors, which can make the process more time-consuming and complex. ETFs can be bought and sold on stock exchanges like stocks during trading hours. This provides investors with more flexibility to trade the fund and to buy or sell at market price. Regular mutual funds and direct mutual funds, however, have a Net Asset Value (NAV) that is calculated at the end of the day, and transactions can only be executed at the NAV price.
ETFs, regular mutual funds or direct mutual funds, each of these instruments has its pros and cons, depending on how you look at them. The right one for you, will – as mentioned earlier – depend on your goals, appetite for risk and of course expertise. So remember to do your research, study your options and go with what feels right.
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