Welcome to our website. this article is all about “ETF vs Index Funds vs Mutual Funds 2023″s full information in simple language to all my friends. Let’s go for it.
Friends! index funds and exchange-traded funds. which we call an ETF in short. These are low-cost funds compared to mutual funds, meaning expense ratio in them are less.we all know this.
So do we never buy mutual funds? It is a very big question that rises, then which product is better between an ETF and an index fund? This is another question that comes to mind? And is it possible that these three products have different use-cases? We are going to know in this article, we’ll do a detailed comparison. We’ll try to understand the past and future trends of index funds, mutual funds, and ETFs in India.
We’ll try to compare this with the US also. You’ll get quite new information to read in the article. The article is going to be interesting.Stay tuned!
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So friends, first we understand
What are active mutual funds?
We all know the mutual fund, that if someone doesn’t want to invest directly in the stocks then he can do it through mutual funds.
Where we get the diversification and our risk gets a bit reduced, we get the expertise of a fund manager.
But here mutual funds are of two types one is active mutual funds and another is passive mutual funds.
In the active-mutual funds, the fund manager regularly tracks the companies. He watches which company is good in today’s time, it sometimes buys, sometimes sells the stocks.
So the main aim of an active mutual fund is that whichever benchmark or index it is comparing,
It can beat that.
For example, if someone is comparing nifty-50. Then whatever returns come in nifty-50, assume nifty-50 increases 15% in any year so the target of the mutual fund is that he has to give returns of more than 15%.
What are Passive Mutual Funds?
But there are other types of funds also, which we call passive funds. Where they follow the index only.
This means their target is not to beat the index. Rather, their target is that they follow the index only, which means they wouldn’t give you alpha returns. And
What can these indexes be?
An index like nifty-50 is one index, Sensex is one index. So if any fund replicates any such kind of fund then we call it an index fund.
This means whatever stocks are in the nifty-50 and whichever the weightage they have they will buy the stocks in the same weightage in that index fund.
They have a similar stock-buying strategy in the ETF. So in the index fund and ETF here are the exact similarities.
And these indices can be other indices also other than the nifty-50 or Sensex. It can be bank nifty,
Someone is investing in the index of IT,
Someone is investing in the FNCG’s index
Someone is investing in the nifty next 50.
So in this way, any one fund can track the different index. But here arises a question,
Why do we invest in them?
That these passive funds, means, we are talking about the ETFs and index funds
If they can’t beat the index then why do we invest in them?
Seeing its answer is quite simple, we need to look into the data.
Mostly you’ll see the funds, especially those which track the big companies mostly they can not beat them data suggest like this.
So maximum people think if no fund is able to beat the index then why do we give more management fees?
because in mutual funds there is a 1-2% management fee. So if they are not able to justify that fee so it is better we invest in passive funds.
Where our expense ratio means our fee is very low. Soon I’ll talk to you about that also.
But before that let’s understand the main differences between ETFs and index funds.
What is the index fund?
The index fund is a kind of mutual fund only means the fund has collected the money from the investor, the fund manager is managing that money, means he is investing in different types of stocks and what are those stocks? They are following any index, as we talked about earlier.
But the main difference of index fund in comparison with mutual fund comes of expense ratio
Here the on-an average expense ratio is 0.1% to 0.3% means the cost becomes almost 1/10th
so this is quite a big difference.
We talk about the ETFs:
So they operate a bit differently than mutual funds. You can understand them as a middle path between mutual funds and stocks.
As we talked about in the mutual funds, they track any index fund, similarly, an ETF also follows an index, which means it will buy the stocks in the same way as they bought in the index.
Also Read: Top 5 Best Mutual Fund For 2023 in India
This means if it is following the nifty-50, then it’ll buy the stocks of the nifty-50 in the same weightage.
But whenever a new fund comes here, at that time only they invest in the new fund. At that time the money comes to that fund.
This means that funds can not increase again and again, like a mutual fund or index fund, assuming it started with 500 crores.
But by increasing its asset under management that tomorrow can be 5000 crores, 10000 crores also. But when an ETF is launched if once 500 crores come with it like in an IPO to any company.
Similarly, if the fund got 500 crores, that means its asset under management is closed, It is going to be 500 crores only.
So the ETF we have got a value. Its shares get distributed among all the investors.
The trading of those shares happen, You invest in this through your Demat account as the trading of the stocks happen similarly the trading of ETFs also happen Broadly the ETF are of 3 types.
One is an equity ETF which means money is getting invested in the stocks.
The second is debt ETF means money is getting invested in bonds.
The third is gold ETF which means investment is done in the physical gold in that.
If we see, ETFs are the second most popular product after the mutual funds Index funds are not so popular now. The reason for that is the cost of ETFs gets even lesser.
It gets less than index funds. Here the expense ratio starts from 0.01%.
ETF vs Index Funds vs Mutual Funds
We’ll mainly focus upon the comparison, let’s see the comparison once.
So first of all, if we talk about trading and pricing, if we invest in an index fund and mutual fund then in that, we get assigned with one unit which we call NAV means net asset value.
As its value increases, that’s your growth, those are your returns.
But if we talk about an ETF, so as we talked earlier, here the fund gets the money once, after that, its shares get distributed with the shareholders.
They got the real-time price means as in the market stocks have the real-time price, similarly, an ETF also gets traded in the market.
So here the price discovery is instant here you don’t have to wait, Like in the index fund or mutual fund whichever the NAV is at the end of the day you’ll invest in that.
In the ETF, whatever is the real-time price you can invest in that. This means its trading also happens intra-day like people do intra-day trading in stocks, they do the same in the ETF also.
Now if we talk about its management, so in mutual funds, there is active management, because here no index is getting followed, whichever stock fund manager likes, he’ll buy, and whenever he feels like it, he sells it.
In the index fund, there is a passive investment, which means an index is being followed. In the ETF also a passive investment is happening.
If we talk about the expense ratio, then it is a bit high in the mutual funds as we talked, here charges are about 1-2%.
But the same question arises, if any fund manager is able to justify his 1-1.5%, assume that he is able to beat the index, he is giving 3% extra returns than the index.
Then definitely, we can pay him, if he is beating the index.
But the same question arises : we’ll have to see the performance of that mutual fund, how has it been in the past?
In the index funds, the expense ratio is medium, as we talked, 0.1-0.3%. In the ETFs, especially when we are talking about equity ETF here it gets even lesser,
The least is in it. In the equity, ETFs expense ratio starts from 0.01%, so this is its highlight, the lowest expense ratio.
And the second highlight we’ve already done here is real-time trading.
There is no requirement for a Demat account in the mutual funds, it is not required in the index funds too, but in the ETF there is a need for a Demat account.
As for buying the stocks, here also you require a Demat account.
And we have to remember one more thing here, when we are trading in the Demat account,
Then obviously, some brokerage of DP charges could be applied. but when we are investing enough money then these charges are quite minimal.
Especially if you are operating with the discount brokers, like Zerodha, Angel broking,
If you don’t have these accounts then you can open them by clicking on them.
Here you don’t charge with the brokerage charges like when we take delivery of any stock, there are no brokerage charges
But DP charge, whenever we sell any stock or ETF, at that time we get DP charges, but they are not so high.
Now if we talk about liquidity, in mutual funds, the liquidity is very high, because in India, there are so many mutual funds.
Liquidity is quite high here. You are investing the money in a fund, whenever you want to withdraw you can withdraw mutual funds that will sell some shares and will give you the money.
If we talk about index funds. so as they are operating as mutual funds. so liquidity is high here.
Both of these are its highlights, it is quite a big plus point, of the index funds and mutual funds.
In the ETFs, the liquidity is low at today’s date, which means not so many people are trading in the ETFs.
But it got improved gradually, if we talk about the 4-5 years. So now in the ETFs, a lot of trading has started.
And if we talk about the US, the market of ETFs is quite big. I’ll talk to you about that soon, we’ll also talk about the data also.
Now if we talk about the effort needed, so in the mutual funds, it is very negligible, in the index funds also very negligible.
In the ETFs, you’ll have to put some effort, because we should understand the pricing properly, at which price I should buy it, as we talk about the stocks, though it is not as tough as stocks.
Still, we should have a little knowledge of pricing Best for, if we talk about mutual funds, data says that,
In the large-cap companies, wherever the mutual funds are investing. they are not able to beat the index.
In such cases, index funds and ETFs become better, because they can not beat in the cases of large-cap stocks.
So it is better for us to save our cost. We do passive investment, we invest in the ETFs,
We invest in index funds. But in small-cap and mid-cap, a fund manager gets quite a big area, enough options, to invest,
So here they are generally able to beat the index, data suggest like this.
Past and Future Trends ( ETF vs Mutual Funds vs Index Funds )
Now let’s talk about the market’s data. How have been the past and future trends?
Compare the data of the US and India.
If we talk about the US first,
So see, till 1995, ETFs and index funds were very less famous. Means very few people knew about them.
They have only 3% assets under management in comparison with the total AUM, which means with the comparison of the total mutual fund industry.
In 2005 it increases to 14%,
in today’s date, it is 41%, it is a huge number,
This means half of the people are investing in active funds and half are in passive funds.
India’s market is a bit behind the USA. But the trend is almost the same here also, If we talk about the passive funds, then in 2016,
Asset under management was 22000 crores, combining the ETFs and index funds. means only 1.4% of the total industry.
In today’s date if we see the latest data of June 2021, if you see the data of index funds, you see index funds are not enough.
Many people say we should invest more in index funds, but the cost there also is not so less, expense ratio is not so less than it is in the ETFs.
In the ETFs, the asset under management is more than 3 lakh crores, which means there is not very much investment being done.
But if we combine its total data, today it becomes 9.65% totally, which means from 1.4% now we reach 9.65%.
And it is being indicated that in the upcoming 5 years also, that this trend will remain the same,
and it will increase to 13.33%.
Which means people are liking to invest in ETFs and index funds, especially when we talk about,
means especially which we are talking about the large-cap,
Where funds are not able to beat the indexes.
So we’ve seen a comparison, talked about the past and future trends.
Conclusion: Which investment to choose?
Now if we want to conclude, then which product is better in which case?
See I understand, ETF is quite a good product,
but in today’s date, there is only one problem
that in it, liquidity is a bit less, though it is not as less as it was 5 years ago, in the upcoming 5 years, according to me, this liquidity will be quite good.
Yes! because of low liquidity, maybe pricing is not that good, that’s why according to me, beginners should have to start investing in the index funds, if they want to invest in any passive fund.
Gradually, as the market’s information increases, they get a little more knowledge about the ETFs, pricing, then they can move into the ETFs.
But we have the use-case of mutual funds also, as we saw, when it comes to small-cap and mid-cap then mutual funds generally justify their fees, so we can definitely invest there.