ETF vs mutual fund: which investment vehicle is right for you?

Making the right investment decisions is critical for successful wealth management and future financial security. A vital choice involves selecting between ETFs and mutual funds. In the UAE, investors can choose from various ETFs and mutual funds to invest in. However, there are critical differences between these two investment vehicles that you need to understand before making an informed decision.

This article discusses factors to consider when deciding which suits you better between ETFs and mutual funds in the UAE.

Cost

The cost of investing in an ETF or a mutual fund should be factored into your decision-making process since it can significantly impact your returns over time. Generally speaking, ETFs have lower fees than mutual funds because they are automated and require less human labour for management, which means investors can potentially save more money with ETFs.

Moreover, in ETF trading, you must typically pay a brokerage cost when buying an ETF on the stock exchange. Purchasing a mutual fund involves paying the sales load or commission the fund manager charges.

Tax efficiency

How taxes are applied on returns from investments should be considered when deciding between an ETF and a mutual fund. Generally speaking, ETFs are more tax efficient than mutual funds due to their structure because, with ETFs, there are fewer capital gains distributions and tax liabilities than mutual funds.

Certain ETFs may also be eligible for reduced taxes in specific circumstances. For example, the UAE-based ETFs listed on SGX may enjoy concessional tax treatments such as 0% withholding tax on any dividend payments received.

Trading flexibility

Another factor to consider when deciding between an ETF and a mutual fund concerns trading flexibility. Generally speaking, ETFs are more convenient and faster when buying and selling since they can be traded on the stock exchange throughout the day. On the contrary, mutual funds are usually sold through fund companies and require you to wait until the end of a trading day for pricing, which can be inconvenient if you need liquidity quickly.

Furthermore, ETFs allow investors to take advantage of market movements more readily than mutual funds since they can be traded in real-time. With mutual funds, investors may not have this luxury since they can only buy or sell at the end of a trading day at whatever price is set.

Investment style

The investment style should also be considered when choosing between an ETF and a mutual fund. Generally, ETFs provide investors access to various securities, such as stocks, bonds or commodities. On the other hand, mutual funds are typically limited to specific asset classes and may offer less flexibility than ETFs in diversifying investments.

Additionally, investors have more control over their asset selection when investing in an ETF since ETFs can be bought and sold at will on the stock exchange. Conversely, mutual funds require investors to hand over control to fund managers who decide on their behalf.

Liquidity

Investors should also evaluate liquidity when deciding between an ETF and a mutual fund. Generally speaking, ETFs are more liquid because they can be traded throughout the day on a stock exchange. Mutual funds, however, only trade at the end of a trading day and are typically less liquid than ETFs due to their structure.

Moreover, ETFs may offer more liquidity in pricing since they can be bought and sold at real-time prices on the stock exchange market. On the other hand, mutual funds require investors to buy or sell at whatever price the fund manager sets at the end of each trading day.

Risk profile

The risk profile should also be considered when deciding between an ETF and a mutual fund. Generally speaking, both options have similar risks, such as volatility, currency risk and counterparty risk. However, ETFs may also be subject to tracking error risk because their performance is linked to the underlying index or asset being tracked. On the other hand, mutual funds are managed portfolios, and, as such, any associated risks typically stem from a fund manager’s decisions.

Additionally, investors should consider whether they are comfortable taking a passive or active approach when managing investments. ETFs offer a more passive approach, while mutual funds provide an active portfolio management style where decisions are made by a professional fund manager who actively manages its holdings on behalf of investors.

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