how is an exchange traded fund (etf) different from a mutual fund?

while reading about the various kinds of investment tools that you can appropriate your income into, etf or exchange traded fund is a term that you must have come across often. for the unintended, exchange traded funds in many aspects are quite similar to the good old traditional mutual funds. nonetheless, also quite different.

simply put, both exchange traded funds and mutual funds are a type of 'pooled funds' wherein investors contribute their money to create a corpus that is re-invested in securities or assets of a particular sector. however, the major difference that lies here is how these securities are traded and the tax treatment they receive.

to make it easy to understand, here below are some of the fundamental differences between these two products:

trading and settlement

the first major difference between etfs and mutual funds is the way these are traded and settled. while mutual funds are traded at the nav or net asset value calculated at the end of the day, exchange traded funds are more liquid and can be bought and sold at their current market price. similar to intraday trading. it can be highly beneficial for investors that continuously track the market as it will help them book quick profits due to price fluctuations.

control and choice

while an etf and mutual fund, in essence, are the same, the way you can invest in them is different. in the case of mutual funds, you cannot purchase them directly. you have to follow a process, fill up forms and contact your fund manager. though a very simple process, it is still time-consuming compared to an etf that you can purchase directly from the open market without the need for an intermediary. thus, in the case of a mutual fund, your fund manager controls the fund's investments, while in an etf, the investors decide where their funds go.

higher liquidity

one of the biggest drawbacks that mutual fund instruments have is the mandatory lock-in period. this lock-in period can be anywhere between 3 months to 3 years. selling or redeeming a mutual fund during this time is prohibited or subject to penal charges. nonetheless, an etf has no such lock-in period attached to it. investors can sell or redeem their exchange traded funds as they please at the prevailing market price - thus making the instrument more liquid.

the better option?

on a closer look, both etfs and mutual funds have their own set of pros and cons. for instance, both the instruments' tax treatment is quite different due to their varied purchase and redemption criteria. moreover, to further understand etfs and your estimated monthly investment amount better, you can also refer to CRED's online calculators.