What is ETF?
An ETF or Exchange-Traded Fund can be explained as a basket of different types of securities.
It is much like mutual funds, however, the difference lies in association with the stock market.
Mutual funds are not traded on stock exchange whereas ETF can be traded on stock exchange.
Another feature of ETF is that it tracks index. Around 85% of the ETFs track equity index.
This is the reason that Investors like to invest in ETF. It offers them an open-ended mutual fund which can be traded all through the day.
This increases the liquidity of ETF making it a favourable investing plan for certain investors.
What is FOF?
A Fund of Funds or FOF is a multi manager investment plan.
It invests in other mutual fund schemes. This is unlike Mutual Fund investment that invests in stocks, bonds etc.
This helps the investors to diversify their risk since the investment is spread across different portfolios.
By doing so, the investor can achieve their diversified investment goals and also invest internationally.
Also Read: Insurance – Meaning, Types and Benefits
ETF vs FOF
Here is a broad comparison between the two terms to make you understand the difference better:
To ascertain the key differences between ETF and FOF, we will use parameters such as liquidity, taxation, cost, transparency and structure.
Based on liquidity:
FOF are generally less liquid investment plan. This is because they generally sell like open-ended mutual fund.
On the other hand, ETF is relatively liquid in nature. This is because they are traded on Exchange. Hence, it allows ETF to be traded all through the day.
FOF invests in diverse securities such as mutual fund, ETF, bonds etc. This is a less transparent investment option as well. It does not disclose holdings and other such information.
Contrarily, ETF is a much transparent investment option. It invests in stock exchange which regulates it to be transparent to the investor and other people of interest.
FOF is a basket of different types of securities. It lets the investor arrange their investment portfolio according to their risk appetite and investment goals.
ETF is much similar to mutual fund in the nature of securities. However, the key difference is that ETF is traded in exchange market and tracks equity index.
ETF is a less costly investment plan as compared to FOF.
This is because ETF do not need to be regulated all the time. It is a passive management investment.
On the other hand, FOF are actively managed. This is because of the diversified investment portfolio. It includes a number of hidden costs.
As for the FOF, the taxes are charged as debt funds. This tax policy has nothing to with the nature of investment.
That is, even if you are investing in equities, you will be charged tax in the form of debt fund on the revenue incurred form it.
ETF is taxed based on three parameters, namely, equity, gold and others.
In equity tax, if the ETF is held for less than one year, then it will be categorized as Short term capital gains, and you will be taxed 15%.
But, if you hold ETF for more than one year, then it will be categorized as Long-term capital gain, and you will be liable for 1 lakh tax exemption.
In gold or other types of taxes, if you hold ETF for less than three years, it will be STCG and you will be exempted tax according to it.
If you hold ETF longer than three years, it will be LTCG and you will be liable for 20% tax with benefits.
The bottom line
You should carefully understand the management and working of both ETF and FOF and then choose.
ETF is a type of investing that requires less hustle and bustle and is perfect for an investor looking for passive investment.
On the other hand, FOF is an active investing plan. You will need to be careful and invest your time along with money in this investment.