Index Funds vs ETFS – What is the difference

By REPAKA PAVAN ADITYA

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Updated on: May 16th, 2025

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4 min read

When it comes to investing, not everyone has the time or skill to pick the “next big stock.” That’s where passive investing steps in. It’s simple, low-cost, and doesn’t require constant tracking. Index Funds and ETFS are two of the most popular options in this space. At first glance, they may seem similar both follow market indices like Nifty or Sensex, but they work in very different ways behind the scenes. If you're wondering which one fits your style better, this guide will clarify things without jargon.

What Are ETFs?

ETFs, or exchange-traded funds, are like ready-made baskets of stocks that follow a market index, such as the Nifty 50 or Sensex. So, if you buy one unit of an ETF that tracks the Nifty, you own small pieces of all 50 companies in that index in the same proportion.

But here’s what makes ETFs unique: They’re listed on stock exchanges like regular shares. You can buy and sell them anytime during market hours, and the price changes in real time, depending on demand and supply. That means you need a demat and trading account to invest in them.

Since ETFs don’t rely on fund managers to pick stocks, their costs are low. It simply mirrors an index and aims to deliver returns that closely match it, nothing more, nothing less. It’s a simple, efficient way to invest across the market without going stock by stock.

What Are Index Funds?

Index funds are mutual funds that aim to copy the performance of a market index like the Nifty 50 or the Sensex. Instead of trying to beat the market, they simply try to match it by investing in all the same companies that make up the index, in the same proportions.

Unlike ETFs, index funds aren’t traded on the stock exchange. You can invest through any mutual fund platform or directly from the fund house. And no, you don’t need a Demat account. You can start with a lump sum or through SIPs, which makes them an excellent choice for beginners or those building wealth gradually.

Since these funds don’t involve active stock picking, the costs are lower than those of regular mutual funds. However, they are priced just once a day at the end-of-day NAV, so you don’t get real-time buying like with ETFs. Still, if you prefer a hands-off, long-term approach, index funds offer a simple and effective way to ride the market.

ETFs vs Index Funds

While ETFs and index funds aim to mirror market indices, their operation differs significantly. 

Feature

ETFs

Index Funds

Trading Method

Traded on stock exchanges like shares during market hours

Purchased or redeemed through fund houses at end-of-day NAV

Pricing

Market-driven, prices fluctuate throughout the trading day

Priced once daily based on Net Asset Value (NAV)

Demat Account

Required for buying/selling

Not needed; can invest directly through mutual fund platforms

Liquidity

High, can buy/sell anytime during market hours

Lower, transactions processed at day's end

Expense Ratio

Generally lower; however, it includes brokerage and other transaction costs.

Slightly higher; includes fund management fees but no brokerage charges.

Minimum Investment

Typically, the price of one unit varies based on the market price

Often as low as ₹100; suitable for SIPs

SIP Availability

Not generally available, but can be done manually

Available; ideal for regular, disciplined investing

Tax Efficiency

More tax-efficient due to the in-kind creation/redemption process

Less tax-efficient; may incur capital gains within the fund

Dividend Options

Usually, the only growth option; dividends may not be distributed

Offers both growth and dividend (IDCW) options

Best Suited For

Active investors are comfortable with stock trading and monitoring markets

Passive investors seeking simplicity and ease of investment

 Advantages and Limitations of ETFs and Index Funds

While both options offer passive exposure to market indices, their structure and usability have distinct advantages and limitations.

Category

ETFs

Index Funds

Advantages

Real-time Trading – ETFS can be bought or sold anytime during market hours, just like stocks. 

Low Cost – They usually have lower expense ratios than index funds, making them cost-efficient in the long run. 

Transparency – Holdings are disclosed daily, giving investors better visibility. 

Tax Efficiency – ETFS may offer better post-tax returns due to in-kind transactions.

Ease of Investment – Can be purchased directly from AMC platforms or distributors without needing a Demat account.

SIP Option Available – Suitable for salaried individuals who prefer regular, automated investing.

 Low Maintenance – Ideal for passive investors who don’t want to monitor markets daily. 

Professionally Managed Execution – Though passively managed, professionals handle operational aspects.

Limitations

Requires Demat & Trading Account—This is an entry barrier for beginners without trading setups. 

Not SIP Friendly—ETFs cannot be invested in through the SIP mode, limiting convenience.

Brokerage Costs Apply—Buying and selling units involve brokerage and transaction charges. 

Market Tracking Needed—Since prices fluctuate daily, timing purchases requires basic market knowledge.

Higher Expense Ratio – Slightly more expensive than ETFS due to fund management and administrative costs. 

NAV-Based Pricing – Units are allotted based on end-of-day NAV, so there’s no control over purchase timing. 

Tracking Error – Returns might slightly deviate from the benchmark due to operational constraints. 

Less Liquid – Redemption and purchase happen once a day, which may not suit active traders.

Which one should you choose ?

Choosing between ETFs and index funds depends on how much you want to be involved in managing your investments. If you already have a Demat account and are comfortable placing trades or watching the market occasionally, ETFs might be a better match. They come with lower costs and can be bought or sold anytime during market hours, which gives you more control.

But if you prefer a more straightforward route, one where you can just start an SIP and not worry about daily market ups and downs, index funds make more sense. You don’t need a Demat account; everything runs in the background, making them perfect for beginners or anyone who doesn’t want to monitor their portfolio actively.

Both options help you invest in the broader market without the hassle of picking individual stocks. The better choice is simply the one that fits your comfort level, routine, and long-term goals.

Conclusion

ETFs and index funds give you an easy way to invest in the market without picking individual stocks. ETFs might work better for you if you want more control and already have a Demat account. But if you’re looking for something simpler, where you can just set up a SIP and not worry about daily market movements, index funds are a great option. Either way, both help you stay invested, diversified, and move steadily toward your long-term goals.

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About the Author

I manifest my zeal in financial quantitative & quantitative research and have been instrumental in creating a robust process for the evaluation and monitoring of mutual funds. I’m responsible for Equity and Mutual Funds Research while creating instrumental mathematical models for portfolio construction after evaluating funds, and I play an integral role in analyzing changes in mutual funds, micro, and macro-economic indicators, and equity market events and trends. My views on asset classes which are integral in creating an investment strategy for any profile. Read more

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