ETF vs Index Fund: Know the Difference Between ETF and Index Fund

Discover the key differences between ETFs and Index Funds with our ultimate guide to making informed investment choices.
EXPLORE FUNDS
4 mins
09 October 2023

Investing in the Indian financial market has evolved significantly over the years, offering a range of investment options beyond traditional investment choices. Two popular investment options that have gained prominence are index funds and exchange-traded funds (ETFs). Both index funds and ETFs provide investors with opportunities to diversify their portfolios and gain exposure to a broad range of Indian assets. However, they differ in several key aspects. Let us explore the features and differences between index funds and ETFs.

Index Funds

Investment Structure:

  • Index funds in India are traditional mutual funds that aim to replicate the performance of a specific stock market index, such as the Nifty 50 or the Sensex.
  • These funds are passively managed and typically aim to hold a portfolio of Indian securities that closely mirrors the index they track. The goal is to achieve returns that closely match the Indian index, and the fund's holdings are periodically adjusted to reflect changes in the underlying index.

Pricing and Trading:

  • Index funds in India are priced based on the net asset value (NAV) of the fund.
  • Investors can buy or sell index fund units at the fund's NAV, which is calculated at the close of the stock market.

Expense Ratios:

  • Index funds in India are known for their low expense ratios, making them cost-effective investment options.
  • Since they are passively managed and do not involve extensive research or trading, their fees are typically lower than actively managed Indian mutual funds.

Exchange-Traded Funds (ETFs)

Investment Structure:

  • An ETF is a type of investment fund that tracks a specific market index, similar to an index fund. However, unlike index funds, ETFs trade like stocks on an exchange throughout the trading day. This means that investors can buy and sell ETFs at any time during market hours.

Pricing and Trading:

  • ETFs in India are traded throughout the trading day, just like individual Indian stocks, allowing investors to buy or sell ETF units at prevailing market prices.
  • Prices may fluctuate based on supply and demand, and Indian investors can use limit orders to specify their purchase or sale prices.

Management Style:

  • ETFs in India can be passively managed, like index funds, or actively managed, where fund managers make investment decisions.
  • Passive Indian ETFs aim to closely track an index, while active ETFs involve active fund management to outperform the index.

Expense Ratios:

  • ETFs in India are known for their competitive expense ratios, which are typically lower than those of actively managed mutual funds.
  • Indian investors benefit from cost-efficient access to a diversified portfolio.

Key Differences between Index Funds and ETFs

Now that we have examined the basics of index funds and ETFs in the Indian financial market, let us understand the key differences between the two investment options:

  • Trading Flexibility: ETFs in India offer greater trading flexibility as they can be bought and sold throughout the trading day at the current market prices. In contrast, index funds are priced once a day at the close of the Indian stock market.
  • Intraday Trading: Indian ETFs allow intraday trading, meaning investors can take advantage of price fluctuations during the trading day. This flexibility is not available with index funds.
  • Redemption Process: Index funds in India can only be redeemed through the fund house at the applicable closing NAV , while ETFs can be bought and sold on the secondary market at market prices.
  • Management Styles in India: While both index funds and ETFs can be passively managed, Indian ETFs offer the option of actively managed funds, allowing for more diverse investment strategies.

What index funds and ETFs have in common

Index funds and ETFs are two types of investment vehicles that bundle together many individual investments such as stocks or bonds into a single investment. They have become popular choices for investors for a few shared reasons. Both index funds and ETFs can help you create a well-diversified portfolio, are passively managed, and have strong long-term returns. Passively managed investments follow the ups and downs of the index they’re tracking, and these indexes have historically shown positive returns.

Choosing Between Index Funds and ETFs in India

In India, both index funds and ETFs are gaining popularity among investors. Both index funds and ETFs offer investors exposure to a diversified portfolio of securities. While both types of investments track a specific market index, there are some key differences between them. Expense ratios for index funds are higher than those for ETFs because mutual funds require more hands-on management. Additionally, minimum investment amounts required for investing in an index fund are generally lower than those required for investing in an ETF. However, ETFs offer more trading flexibility than index funds since they trade like stocks on an exchange throughout the trading day.

The choice between index funds and ETFs depends on your investment objectives, trading preferences, and overall financial plan.

Frequently asked questions

What is an ETF?

An ETF (Exchange Traded Fund) is a type of investment fund that is traded on stock exchanges, similar to stocks. It holds assets such as stocks, bonds, or commodities and aims to track the performance of a specific index.

What do Index Funds and ETFs Have in Common?

Index funds and ETFs both bundle together many individual investments such as stocks or bonds into a single investment. They have become popular choices for investors for a few shared reasons. Both index funds and ETFs can help you create a well-diversified portfolio, are passively managed, and have strong long-term returns.

Which is the safer option for investment between an Index fund and Exchange Traded Fund?

Both index funds and ETFs have similar risk profile, since they invest in well-established companies with a proven track record of performance. However, like all investments, they carry certain risks.

Which is the more widely traded form of investment in the market?

ETFs are more widely traded than index funds because they can be bought and sold on an open exchange, just like regular stocks.

Which form of investment is more convenient?

ETFs are considered more convenient to enter or exit than most mutual funds. ETFs can be traded more easily than index funds and traditional mutual funds, similar to how common stocks are traded on a stock exchange.

Can an investor invest in the form of SIP?

Yes, investors can invest in both index funds and ETFs through SIP (Systematic Investment Plan).

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