ETF

Understanding ETFs vs FOFs

Comparing ETFs and FOFs to choose a balance between low-cost liquidity and expert-managed diversification for your investment goals.

Team Dhan

31 Jul 2025 — 3 min read

Photo by Precondo CA / Unsplash

Picking the right investment tool can make or break your financial journey. Two popular options, ETFs (Exchange-Traded Funds) and FOFs (Fund of Funds), offer distinct advantages based on your goals. ETFs are known for their low cost and easy trading, while FOFs bring expert management and built-in diversification.

What is an ETF?

Investment funds that trade on stock exchanges are called ETFs. They allow investors to simultaneously purchase and sell various assets like bonds, stocks, or commodities. They provide investors access to market indexes, asset classes, or sectors.

They come up with low fees, allow daily trading, and ensure high tax efficiency. Moreover, they are passively managed and present clear information about their holdings.

Investors can choose from several ETFs based on risk level and investment goals. So, ETFs ensure flexibility in the financial markets.

Why consider an ETF?

ETFs are the right fit if you're looking for a smart, flexible, and cost-effective investment method. Here’s why:

Low-cost access to multiple assets: ETFs offer exposure to a mix of stocks, bonds, or commodities with minimal fees.
High liquidity: You can buy or sell them anytime during market hours, making them ideal for investors who prefer flexibility.
Transparency: Regular updates on holdings help you stay informed about what’s inside the fund.
Targeted exposure: Perfect for investors seeking simple and direct access to specific market indices or sectors.

What are FOF?

FOFs is a type of mutual fund that allows you to invest in multiple funds via a single investment. In other words, it means a kind of mutual fund investing in other mutual funds. It doesn’t allow direct investment in stocks or other financial instruments. Rather, it allows investment in a portfolio of different mutual funds.

Why consider a Fund of Fund (FOF)?

If you want to invest without much effort and still benefit from diversification and expert help, FOFs can be a smart choice. Here are the main benefits:

Diversified Exposure: FOFs invest in multiple mutual funds, offering broad diversification across fund managers and strategies.
Risk Reduction: By spreading investments across various funds, FOFs help lower the overall investment risk.
Professional Management: They are handled by skilled fund managers specialising in asset allocation and portfolio balancing.
Low Maintenance: FOFs require minimal monitoring, making them suitable for investors with limited time or investment knowledge.

The key differences

Want to know the difference between ETF and FOF? Here's a quick look at how they work and what makes them different.

Parameter	ETFs	FOFs
Structure	ETFs invest directly in securities like stocks, bonds, or commodities.	FOFs invest in other mutual funds instead of directly in stocks or bonds.
Liquidity	Highly liquid stocks like shares can be bought and sold anytime on the stock exchange.	The less liquid you are, the less you can trade them instantly; redemptions take longer.
Investment	Directly holds assets and shows daily holdings for transparency.	Invests in other funds; holdings may be disclosed periodically, not daily.
Taxation	Short-term gains are taxed at 15%, and long-term gains at 10% above ₹1 lakh.	The tax depends on underlying funds: equity-based FOFs follow equity tax rules; debt-based FOFs follow debt rules.
Cost	Lower cost, as most ETFs are passively managed.	Higher costs are due to dual fees, one for managing the FOF and another for the funds it invests in.
Diversification scope	Limited to the index or assets the ETF tracks	Offers higher diversification by investing across multiple mutual funds and asset classes.
Flexibility	Less flexible follows a fixed index.	More flexible fund managers choose from various funds to balance the portfolio.

Which is right for you?

ETFs work well for investors looking for affordability, transparency, and liquidity. FOFs are suitable for those investors who prioritise professional management and broad diversification of portfolios. After going through the ETF vs FOF differences, you can make a wise decision by considering the following points:

When to choose ETF	When to choose FOF
If you aim to track specific sectors or market indices.	If you aim to get exposure to multiple asset classes and funds with minimum risk.
If you want to prioritise passive investing at low management fees.	If you want a practical approach and get insights on asset allocation from fund managers.
If you need flexibility to buy and sell during trading hours.	If you can afford to pay high fees for expert management.

Make smart investment decisions today

Be clear about your investment needs and objectives before making a choice. ETFs provide advantages like trading flexibility and liquidity, whereas FOFs benefit you with active management and broader diversification, though they may cost more. Understanding the key differences between ETFs and FOFs helps you choose what fits your financial goals best. It also helps you get better returns while staying within your risk limit.