Mutual Funds vs ETFs
Well, these are some financial instruments out there. which retail investors mainly focus on and invest in. This walth post is going to explain them in an easy way with some pros and cons it has. Without further intro let's get started.
You might have heard this team on TV or on the internet, advisements, and maybe from your friends and Mutual friends 😉.
So, here is how mutual funds work. There is a person called fund manager, who works for a company X(called a fund house) they form a Mutual Funds. Now you and your couple of friends decide to invest in the stock market, but you guys have little( and obviously you don't have to be rich to invest in the stock market) fine, now there are many people like you.
Here is where company X comes into action with Mutual Funds. If all of you guys invest in their mutual funds. There are basically pooling all your money(once they do this they will have a huge sum right?) and invest the money in the stock market with a certain theme like,
they will invest your money in Big companies(large caps) or companies that pay dividends. etc.
There are many mutual funds out there with such different themes, it's your choice to choose what to invest in, and that guy fund manager will allocate your money based on the theme.
Now, why would the company do all these things for free? That's why they collect a small percentage fee for handling your money. That percentage is called the expense ratio of the fund
lower the expense ratio, higher returns you will earn in the longterm.
Check this post to know how a higher expense ratio can affect your returns. That's just an introduction to mutual funds. There will be separate walth post on mutual funds and others so, make sure to subscribe to this blog down there.
Advantages and disadvantages of Mutual Fund
A good way for diversification
Actively managed by a fund manager
Simplicity(you don't have to spend much time on research) and some mutual funds are tax-efficient too.
Easy liquidity i.e you can easily sell your mutual fund and get your money.
One of the biggest disadvantages of a Mutual fund is the Expense ratio(a percentage of your profit they take for managing your money) and typically MFs have a higher expense ratio like 1% to 2%. That might not appear like a big number but a fund with a higher expense ratio will cost you a lot in the long term.
Mutual funds are over diversified( diversification is good but over-diversification will reduce your returns). Diversification protects you from risk but also reduces your profits.
Lack of control. You don't choose where your money gets invested it, I mean you can choose any mutual fund but you can't manage where the money will get invested only a fund manager will do it.
Lock-in period. MFs have a thing called the Lock-in period. which means you are not supposed to sell your mutual funds for a certain period of time say 1 year from the investment. If you choose to sell before the lock-in period, you gotta pay some fees called exit ratio.
Exchange-Traded Funds (ETFs)
This is a kind of an interesting asset and a simple thing with no strings attached unlike mutual funds, where there is a thing called exit ratio.
ETFs are a basket filled with stock I mean not literally or it can be regarded as a readymade portfolio and it is traded in the stock market like a stock, You can buy and sell an ETF like a stock. Let me be more clear.
There is an ETF called NIFTYBEES and it priced at 152 rupees as of Feb 1, 2021.
NIFTYBEES ETF tracks the Nifty 50 index. So it has the stocks present in the Nifty 50 index.
stocks like TCS, Nestle, HDFC bank Infosys, etc..
So if you buy NIFTYBEES ETF for 152 rupees. Your money will get invested in all the stocks that are present in the nifty50 index based on their weight in the index.
For example, Reliance holds 10% in the nifty 50 indexes so, 10% of your 152 rupees will get invested in Reliance.
And there are many kinds of ETFs as well. like Sector ETF, Commodity ETF. sector ETF such as NETFIT has stocks that represent in the NIFTY IT index, commodity ETFs such as GOLDBEES, which invest your money in gold.
Advantages and disadvantages of Exchange Traded Funds
ETFs are an excellent way for diversification
They typically have a very low expense ratio, unlike mutual funds. The expense ratio of a typical ETF will be from 0.5% to 0.50%.
It is traded like a stock. You can buy it and sell it like a stock.
Since it is traded like a stock. It is easy liquidity. You can just sell it like a stock and it doesn't have any exit load.
You can buy it in small quantities.
ETFs track an Index, It can experience tracking error. ETF with low tracking error is considered to be good.
You can't do SIP or dollar-cost averaging(automatically investing your money in the fund every money) with exchange-traded funds.
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