Index funds and exchange-traded funds (ETFs) might seem similar, but they are not the same. They are two of the most popular passive investment options. If you are not sure as to which of the two suits you, then read the following to make an informed decision:
1.What are ETFs?
An exchange-traded fund
consists of shares that constitute widely followed indices such as NSE Nifty 50 and BSE Sensex. If an ETF is tracking a particular index, then that index would contain the same stocks like that of the index, and their weightage shall also be the same. Additionally, the ETF may also invest in money market instruments for the sake of liquidity. ETF returns are generally predictable and will be close to what its underlying index earns. Nevertheless, despite many ETFs track the same index, their returns will not be the same as their debt holdings differ, which affect their returns. The units of ETFs are traded on stock exchanges, similar to shares.
2.What are Index Funds?
The asset allocation an index fund
tries to replicate that of a popular index that it is trying to emulate. As index funds are not having liquidity of their own, hence they invest more in liquid securities. Therefore, index funds having tracking error. The deviation of the returns that an index fund would generate from the returns that of its underlying index is directly proportional to the tracking error.
The units of ETFs can be bought and sold on the stock exchanges
, as the name suggests. Therefore, if you are to invest in ETFs, then you mandatorily need to have a Demat account. A minimum of one unit has to be bought, and this can be done the same way you buy or sell a regular share on a stock exchange through a recognised broker.
The index funds are regular mutual funds. You can invest in a lump sum or systematic investment plans
(SIPs) in order to buy units of index funds. Demat accounts are not compulsory to invest in index funds. However, having a Demat account is beneficial in many ways for investors.
When it comes to ETF investments, there are no recurring charges. Besides Demat account’s annual maintenance charge, another cost that you as an investor would have to bear is the transaction charge, which is restricted to under 5%.
When compared to ETFs, index funds have numerous charges. Transactions above Rs 10,000 are levied with a transaction fee of Rs 100. Unlike ETFs, the index funds come with expense ratio
, a recurring charge in the range of 1% to 1.8%. Investors are to pay expense ratio even if there are no transactions made. Apart from that, if you are to exit the fund within a specified timeframe, then you are liable to pay exit load.
||Tracking the performance of indices of a particular exchange
||Replicating the performance of a given index
|How are they traded?
||Traded like a stock on an exchange
||Units of index funds are issued like any other mutual funds
||The pricing follows the principle of shares
||The NAV of the fund differs due to various factors
|Factors affecting the price
||Demand and supply for the security in the market
||NAV of the fund and the assets underlying
||A transactional fee is applicable
||No transactional fee and commission
ETFs might seem to have a clear advantage over index funds as they come at a lower cost. However, you may not be in a position to track markets and take decisions accordingly. This may be due to a lack of market knowledge or time constraint. In this case, you can invest in direct index funds as they come at a lower cost than regular index funds. Also, index funds are handled by professional fund managers, and they take the right decisions depending on the market scenario.