Answering an age old question of Mutual Funds vs. ETFs.
In the United States, ETFs outperform mutual funds because of the taxation structure around mutual funds. Every time a mutual fund in the USA buys and sells a security, it is taxed in the hands of the unit holder as a capital gain distribution, which increases the transaction costs. ETFs passively track the performance of an index, meaning they typically rebalance their holdings only when the underlying index changes its constituent stocks. Such adjustments don’t trigger immediate taxable gains distributions to shareholders, making the transaction costs and expense ratios lower to own an ETF, which gives a higher chance of earning more from an ETF than a mutual fund.
In Indian Mutual Funds and ETFs, there is a tax arbitrage advantage since there is no tax for realised capital gains for the fund. The unit holder is taxed only if the unit holder sells units of the fund for a capital gain. So the effect of compounding works harder here for you. An actively managed fund is more likely to give you a better return than a passively managed ETF due to this reason.
Don't miss out on investing in mutual funds because you heard someone say ETFs give better returns than mutual funds. I learnt the hard way, hope this helps you learn without making the same mistakes as me!
Regards,
Compound Wealth
(AMFI Registered Mutual Fund Distributors)
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