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ETF is one of the popular investment instruments among investors. Similar to the mutual fund, ETF is a pooled investment by many investors, but it has a different structure and operation. This article will briefly explain the differences between ETFs and mutual funds, so it can help you to make an investment decision that suits you.
What are ETFs?
ETFs are exchange-traded funds that track the performance of specific commodity, asset, sector or indexes like the NASDAQ-100, S&P 500, or Dow Jones. It is essentially a fund that behaves like an equity or a mutual that is traded on a stock exchange. ETFs have two basic components: (1) they trade on an exchange, and (2) they do not require active management when they merely attempt to mimic the performance of an index by having a portfolio that represents the index’s components.
ETF vs Mutual Funds
The table below shows the distinct features between ETFs and mutual funds;
| Exchange-Traded Fund (ETF) | Mutual Fund | |
| Diversification benefits | Yes | Yes |
| Transparency | More transparent | Less transparent |
| Fund information | Market price and trading activity data are readily available via the stock exchange or broker | Information is available from the fund manager and the fund’s appointed agent |
| Liquidity | Generally more liquid | Generally less liquid |
| Entry fee | Brokerage fee, clearing fee and stamp duty are applicable when trading on the exchange, generally lower than mutual fund | Ranges from 3%- 5% (for equity funds) |
| Management fee | 0.4%-0.5% p.a. of the NAV | 0.75%- 5% p.a. of the NAV |
| Purchase settlement | T+3 (if through brokers) | Upfront, usually deducted from purchase proceeds |
| Trading is done via | Brokers or participating dealers | Agents |
| Daily trading period | May change throughout the day | Fixed throughout the day |
The primary advantages of exchange-traded funds (ETFs) over traditional mutual funds are quite tempting. They pay less in fees. While both types of funds provide diversification, ETFs tend to be more cost-effective.
More common approach in mutual funds is active management. However, ETFs mostly follow a passive management approach, where the managers do not pick individual stocks based on research and analysis. They simply follow the constituents of the index they are tracking.
The abovementioned comparison between ETFs and mutual funds will help investors choose their investment decision based on their risk preference.
Note: Muslim investors should check the Shariah-compliance of funds before investing.
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