Mutual fund investment and ETFs

Mutual Funds - image

Mutual fund as an investment vehicle is becoming an increasingly popular investment option for retail investors in India. The minimum investment requirements for investing in mutual fund schemes are quite small, making them accessible to all investors (big or small), as effective solutions for a wide variety of investment needs. Retail investors usually associate mutual funds with equity investments, but mutual funds also provide a range of fixed-income investing solutions for different investment tenures and risk capacities.  Generally, these mutual fund investments are known as active funds.

Mutual funds India also offers another type of mutual fund known as exchange traded fund or ETF. These are also known as passive funds.

Whether it is an active or passive mutual fund, the investment is quite simple. If you have a Permanent Account Number (PAN) and address proof which can be verified by the Asset Management Companies (AMCs) as part of Know Your Customer (KYC) requirements, you can invest in mutual funds. You can invest either in a lump sum (subject to minimum investment limits, which almost all retail investors can easily manage) or through a systematic investment plan (SIP), where you can invest from your regular savings on a regular basis (e.g. weekly, fortnightly or monthly, etc.).

However, when you invest in ETF or exchange traded fund, you need to have a demat and trading account as unlike active funds, ETF schemes can only be bought or sold through stock exchanges just like any other traded stocks. When you buy ETFs from stock exchanges, you pay the price prevalent at the time of your trade. This price can be higher or lower than the actual NAV of the ETF.  However, you cannot invest in ETF through SIP mode.

As far as active funds are concerned, the transaction always happens at the mutual fund NAV which is declared at the end of the day, daily after trading hours. This is a very big difference between an active and passive fund.

Another difference between active mutual fund schemes versus passive schemes is the TER (total expenses ratio). The TER of an ETF is quite low as the fund aims to replicate the return of the benchmark or index it is following. But on the other hand, active mutual funds always try to beat the benchmark and create alpha for the investors. To do so, the active mutual funds charge a higher fee, i.e. TER.

Mutual Fund and ETF investments are among the most flexible and transparent investment options in India. If you invest in open-ended funds, you can redeem (withdraw your money) partially or fully at any time; redemptions within the exit load period (if applicable), however, involve some charges. You can stop your Systematic Investment Plan (SIP) at any time and restart it at any time in active mutual fund schemes. Unlike life insurance plans, the underlying portfolios of mutual funds are transparent for all investors. Mutual funds and exchange traded funds are regulated by the market regulator SEBI, whose primary mandate is to take care of investor interests.  

Mutual Fund Investments also offer tax benefits if you invest in mutual funds equity-linked savings schemes (ELSS). These schemes qualify for deduction from your taxable income under Section 80C of the Income Tax Act 1961 with a maximum investment amount of Rs 150,000 in a financial year. ETF mutual funds have also started offering ELSS mutual funds. Therefore, mutual fund investors can now invest in exchange traded funds through active as well as passive mutual fund schemes.

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