Are Mutual Funds Making You Poor? The Case for ETFs Over Traditional Funds

For years, the standard financial advice given to retail investors has been simple: “Start an SIP in a Mutual Fund.” However, financial influencer Pushkar Raj Thakur argues that this advice might be costing investors significantly due to hidden fees, tracking errors, and commission structures.

This article breaks down the mechanics of how Mutual Funds (MFs) operate versus Exchange Traded Funds (ETFs) and why switching strategies could save you crores in the long run.

1. The Glaring Return Gap: Tracking Error

One of the most immediate red flags highlighted is the Tracking Error. This is the divergence between the price behavior of a position or a portfolio and the price behavior of a benchmark.

Using the example of the Motilal Oswal India Defense theme, the video compares the Index Fund version against the ETF version of the exact same underlying assets:

Defense ETF: ~2.17% Tracking Error (Returns were ~26% in the example period).
Defense Index Fund: ~0.27% Tracking Error (Returns were ~16% in the example period).

Despite the Index Fund having a lower theoretical tracking error, the actual returns were significantly lower (a 10% gap in this specific snapshot). The argument is that while the underlying stocks are the same, the structure of the fund and how it manages cash flows leads to lower realized returns for the MF investor compared to the ETF investor.

2. The Silent Wealth Killers: Fees and Loads

Most investors assume that once the expense ratio is deducted, the rest is profit. However, the calculation is more insidious.

The Expense Ratio Disparity

The expense ratio is charged on your total investment value (AUM) every single year, not just on your profits or your initial capital.

Nifty Index Fund: Expense ratio approx $0.20\%$. On a ₹1 Lakh investment, you pay ₹200.
Nifty Bees ETF: Expense ratio approx $0.04\%$. On a ₹1 Lakh investment, you pay ₹40.

This is a 5x difference in cost. While the absolute numbers seem small on ₹1 Lakh, they become massive when managing a portfolio of ₹1 Crore or more over 20 years.

The Exit Load

Mutual Funds: Typically charge an exit load (often 1%) if you withdraw within a specific period (usually 1 year). Even in long-term SIPs, the units bought in the last 12 months are subject to this load upon redemption.
ETFs: Have zero exit load. You can buy and sell at will without a penalty fee to the fund house.

3. The Mathematics of 1%: A ₹1.5 Crore Difference

Does a $1\%$ difference in fees really matter?

Pushkar Raj Thakur illustrates this with a long-term compounding example.

If an investor commits to a ₹25,000 monthly SIP for 25 years:

Scenario A (Mutual Fund at 12% Return): Result is approx ₹8.5 Crores.
Scenario B (ETF at 13% Return – saving 1% in fees/errors): Result is approx ₹10 Crores.

The Insight: By simply choosing an investment vehicle with lower fees (ETF) over a high-fee vehicle (Regular Mutual Fund), the investor saves ₹1.5 Crores. This is wealth transferred from the fund house back to your pocket.

4. Why Are Mutual Funds Pushed So Aggressively?

If ETFs are mathematically superior regarding costs, why do agents sell Mutual Funds?

The Distributor Commission Model:

Certified Mutual Fund Distributors earn a commission on the AUM (Assets Under Management) they bring to a fund.

If a distributor manages clients with a total of ₹12 Crore invested, and the commission is 1%, they earn ₹12 Lakhs/year.
As the client’s money grows (e.g., to ₹20 Crore) via market appreciation, the distributor’s commission grows (to ₹20 Lakhs), even if no new money is added.

This incentivizes distributors to keep clients in Regular Mutual Funds rather than Direct Funds or ETFs, where commissions are non-existent or significantly lower.

5. Active Funds vs. The Index

The video touches upon the “Alpha” argument—the idea that active fund managers can beat the market.

The Reality: The vast majority of actively managed funds fail to beat their benchmark index consistently over the long term.
The Odds: With over 1,400 mutual fund schemes available, picking the specific one that will outperform the market is statistically difficult—akin to predicting the best player in a fantasy cricket league.

6. Actionable Advice: How to Switch to ETFs

The video recommends shifting focus to ETFs (like Nifty Bees) and setting up automated investments.

Step-by-Step SIP in ETFs:

Open a Demat Account: Unlike MFs, you need a Demat account to buy ETFs.
Select “Investor Mode”: In your broker app, switch from trading to investing.
Choose the Asset: Search for “Nifty Bees” (or your preferred ETF).
Set up SIP:
- Select SIP (Systematic Investment Plan) option.
- Choose Quantity or Amount (e.g., ₹2,500).
- Select Frequency: You can choose Monthly or even Weekly.
- Select Day: Choose a specific day (e.g., Tuesday or Friday) for the deduction.

Summary Comparison Table

Feature	Mutual Funds (Regular)	ETFs (Exchange Traded Funds)
Expense Ratio	High ($0.2\% – 1.0\%+$)	Very Low (~$0.04\%$)
Transaction	End of day NAV	Real-time market price
Exit Load	Yes (usually 1% if <1 yr)	No
Commissions	High (for distributors)	None/Low (Brokerage only)
Tracking Error	Generally Higher	Generally Lower

Conclusion

The core message is that while Mutual Funds are a valid investment tool, the structure of ETFs allows for higher efficiency, lower costs, and greater control. By eliminating the “middleman” costs and the compounding effect of high expense ratios, investors can potentially secure significantly higher wealth for their future.

tutorao.com