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Index Funds Vs ETFs : Top Differences You Must Know

23 December 2021
4 minutes

In modern times, investors can hardly find the time to take care of their investments. They usually find ways to invest into passive investment streams where their money is managed by professional fund managers who invest and trade the investment on the investor’s behalf.

Index funds and ETFs (Exchange Traded Funds) are popular passive investment schemes where the investment is usually handled by professional fund managers. But what is an Index fund and an ETF? And which is the better form of investment? 

You can find the answers to these questions in this article. Let’s have a look. 

Index Funds 

Index funds are like mutual funds where the investment is made in securities and further diversified in shares, bonds, and commodities. However, these index funds mostly try to trade as per the popular indices such as NIFTY 50 or SENSEX 100. Because of this, investors enjoy dual benefits of investing in risky shares with lower risk, as the index fund ensures that the investment does not fall from the benchmark, irrespective of market conditions. 

Index funds provide good returns with long-term wealth creation benefits, thus, gaining popularity as a convenient passive investment option for investors.

Some of the characteristics of index funds are as follows:

  1. An index fund is an open-ended mutual fund scheme where the investor can invest and redeem the investment at their convenience.
  2. Index funds offer both growth and dividend options, which helps the investor to choose their risk appetite for the investment. 
  3. It is managed by fund managers who trade on behalf of the investor and ensure that there is minimum loss or no loss in the investment value with maximization of profit. 
  4. Index funds charge higher management expense fees to pay the fund managers and the AMC charges, which can be costly for the investor. 

ETFs 

ETFs or Exchange Traded Funds are funds that mostly trade in the intraday shares market and clock the profits at the end of the day. ETFs are highly transparent in nature, where investors get to know exactly where their investments are allocated. Like with index funds, ETFs are also affected by the share market, and these transactions take place on a real-time basis. Some examples of ETFs are industry ETF, bond ETF, currency ETF, commodity ETF, inverse ETF, etc. 

Some of the characteristics of the ETFs are as follows:

  1. ETFs have lower expense ratios but higher trading costs. 
  2. Investors need to have a DEMAT account to invest in ETFs as they are traded exactly like the share market. 
  3. Investors also earn dividend income on the basis of ETFs, which they can further re-invest in the share market.
  4. ETFs are entirely dependent on the liquidity of the share market, where bearish trends in the market can bring losses for the investor. 
  5. Investors get daily intimation of the portfolio of their investment.
  6. In the same manner as index funds, an investor can invest and redeem their ETF investment at any time as per the convenience.
  7. Investors do not get growth options in ETFs in comparison to index funds, which provide growth options. 

The Main Differences Between Index Funds and ETFs

Thus there are many similarities and differences in Index funds and ETFs:

  • There is no requirement for a Demat account to trade in index funds, but trading in ETFs requires a DEMAT account. 
  • Investors can invest in index funds through SIPs but cannot invest in an ETF in the same manner.
  • Index funds have higher expense ratios than an ETF.
  • In comparison to index funds, ETFs provide flexible trading options while index funds are managed mainly by fund managers.
  • The valuation of the funds is done continuously in an ETF, whereas the valuation of index funds is done at the end of the day.

Thus, it can be said that ETFs are traded like stocks, while index funds are traded like mutual funds. 

Key Takeaways 

  • ETFs are known to be traded in mostly intraday shares via AMCs and can give higher profits.
  • Index funds are known to trade primarily in securities via AMCs and offer more security in investment. 
  • In comparison, ETFs are a much riskier form of investment than index funds. 

FAQs on Index Funds Vs ETFs

Q1. Which is the safer option for investment between an Index fund and Exchange Traded Fund?

ETFs are a good investment for better growth, whereas index funds are a safer form of investment.

Q2. Which is the more widely traded form of investment in the market? 

Index funds are a widely traded form of investment compared to ETF funds.

Q3. Which form of investment is more convenient?

Index funds are the more convenient form of reinvestment. 

Q4. Which investment form diversifies the investor’s risk? 

Index fund diversifies the investor’s risk in comparison to ETFs. 

Q5. Can an investor invest in the form of SIP?

An investor can invest in an index fund via SIP, whereas this cannot be done to trade when  trading in ETFs.

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