The key to success in investing is diversification. An investor shouldn’t invest their capital in a single asset or fund. While it comes to diversification, there are two options available, which include ETF and FOF.
In today’s blog post, we will give you an overview of ETFs and FOFs along with their key differences.
What are ETFs?
ETFs are commonly known as Exchange Traded Funds and are a passive investment option offered by Asset Management Companies. ETFs predominantly invest in a basket of stocks or other assets. ETF tries to mirror the performance of the underlying index in which it invests. They are traded like any other stock on the exchange. To purchase and sell an ETF one is required to have a demat and trading account.
Features of ETFs
The key features of ETFs are as follows:
- Exchange Traded: The ETFs are traded on the stock exchange like any other stock. Hence, one can trade in it during the trading hours only.
- Demat Account: It is mandatory to have a demat and trading account if you wish to invest in ETFs.
- Cost-Effective Investment: Exchange Traded Funds or ETFs generally have lower management fees because of a passive investment approach. Hence, they are suitable for investors seeking cost-effective diversified investment options.
- Diversification: The amount invested in ETFs is diversified into several securities. Hence, it provides portfolio diversification through a single investment and reduces risk.
What are FOFs?
A Fund of Funds is a type of fund offered by asset management companies that invests in units of other mutual funds or ETFs and does not directly invest in securities. In FOF, a fund manager selects a mutual fund or ETF based on their investment objective and invests in it. Unlike ETFs, it does not require a demat and trading account.
Features of FOF
The key features of FOF are as follows:
- Investment in Other Funds: FOFs invest in the units of other mutual funds or ETFs instead of directly investing in stocks and other securities.
- No Requirement of a Demat Account: As in the case of investment in stocks and ETFs, having a demat account is mandatory. But it is not essential to have a demat account while investing in FOF.
- Higher Expense Ratio: FOF generally has a higher expense ratio as investors have to pay the expense ratio of FOF along with the underlying fund.
- Global Market Access: Many FOFs invest their money in various international funds, which allows an investor to diversify their portfolio globally.
Read Also: ETF vs Index Fund: Key Differences You Must Know
Difference between ETFs and FOF
The key difference between ETFs and FOFs is as follows:
| Particular | ETFs | FOFs |
|---|---|---|
| Investment | ETFs invest their money in a basket of index-tracking the performance of the underlying security. | FOF invests their money in the units of other mutual funds or ETFs. |
| Purchase Option | ETFs can be purchased on the stock exchange during the trading hours. | Investment in FOFs can be made anytime, like mutual funds. |
| Trading and Demat Account | It is mandatory to have a demat and trading account if one wishes to invest in an ETF. | A trading and demat account is not required to invest in FOF. |
| Expenses | ETFs generally have a lower expense ratio, offering a cost-effective investment option. | The expense ratio is generally higher in FOF due to layers of fund management. |
| Change in Price | The prices of ETFs change throughout the trading session. | The NAV of funds are disclosed at the end of the trading day. |
| Transparency | The portfolio of ETFs is disclosed daily. | The transparency of the FOF depends on the underlying funds. |
| Flexibility of Investment | Investors can place different types of orders, such as limit orders, market orders, etc. | Such trading features are not available in FOF. |
| Brokerage | Brokerage and other charges are applicable while investing in ETFs. | Investors are not required to pay any brokerage charges. |
ETF or FOF, which one should you choose?
Both ETFs and FOFs offer different types of investment avenues for investors. If you have a demat and trading account and prefer a low-cost investment option, then you can consider investing in an ETF. On the other hand, if you want to have a simple mutual fund-type investment, then you can invest in FOF. They both offer diversification in a portfolio. However, the ultimate choice depends on the investor’s investment option and risk profile.
Read Also: Gold ETF vs Gold Mutual Fund: Differences and Similarities
Conclusion
On a concluding note, both ETFs and FOFs offer an investor an opportunity to diversify their portfolio through a single investment option. ETFs are traded on a stock exchange similar to any other stock. Whereas FOFs are like a mutual fund which has different mutual fund holdings as its underlying assets. FOF does not require regular monitoring, unlike ETF. However, both ETFs and FOFs carry certain risks related to market volatility. Therefore, it is advisable to consult your investment advisor before making any investment in these two.
Frequently Asked Questions (FAQs)
Do ETF and FOF both track the index?
ETFs are a passive investment option which tracks the performance of different indices. However, FOF invests their money in various mutual fund units, which can either be an index or an active fund.
Which is a more cost-effective investment option between ETF and FOF?
ETF is a more cost-effective investment option because it has a lower expense ratio and is passively managed. FOFs have a slightly higher cost as it also involves the expense ratio of the underlying fund.
Is a Demat account required to invest in both ETF and FOF?
No, a Demat account is only required for investment in ETF, not for FOF. ETFs are traded on the stock exchange, and FOFs can be bought and sold similarly to a mutual fund.
Can I invest in an ETF anytime?
No, as ETFs are traded on the stock exchange, they can be bought and sold during market hours.
Do FOF invest in international funds?
Yes, various FOFs invest their money in international mutual funds and ETFs. Through which an investor can diversify their portfolio globally.
