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Index Fund vs ETF?

Is index fund better than ETF (Exchange Traded Fund)? Which index fund should I invest in? Which ETF should I invest in?

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3 Approved Answers

Pijush Kanti Biswas

For index funds, whole index of stock market is used as an instrument of investment. Index funds buy all the stocks in a particular index in the same proportion as its respective index, thereby performing in coherence with the index.

Three options are available in India for investing in index fund:

  • The Sensex having 30 companies
  • The Nifty having 50 companies
  • An index plus fund- mixer of investing in index and partially in actively managed assets.

Few examples of Index fund are:

Exchange-traded fund(ETF) is kind of an index fund that invest in an index, a commodity, currencies, bonds etc. ETF is an excellent investment instrument for achieving investor’s goals, provided used wisely.

Few examples of ETF are:

Both ETFs, and index funds are very popular among investors and these instruments have advantages over actively managed mutual funds. But ETF includes almost every investing asset class including commodities or currencies, giving you exposure of any market, any sector in the world. Whereas, index funds have limited options. The question of whether to include them in your investment portfolio is largely decided by whether they suit your personal investment style, strategy and goals.

Happy Investing!

Vaneet

ETF or Exchange Traded Fund is a fund which consists of a basket of stocks or securities of index that can be traded over exchange. These funds have same composition as the index such as Sensex, Nifty,etc.

An index fund on the other hand is a type of mutual fund in which a portfolio constructed so as to match the components of a market index, such as the Standard & Poor's 500 Index (S&P 500). These funds replicate the performance of market benchmark.

Some of the characteristics of these funds are:

  • Both are passively managed funds
  • Both funds need not be actively managed by the Fund Managers. The returns of these funds closely track the benchmark Index

Differences:

  • Index Funds can be purchased only at the end of the day. Index ETFs are available for trade throughout the day
  • In ETF, dividend gets directly credited into the investor's registered bank account. In index funds an investor has the option of growth plan, wherein his returns are reinvested to purchase new units of fund 
  • Higher tracking error risk in case of index funds than as compared to ETFs
  • Expense ratio of index fund is higher in comparison to ETFs
  • In ETFs there are costs such as brokerage, STT and statutory charges

The market of index funds is fairly new in India.

For information on various index funds available in India, click here.

For information on various ETFs in India, click this link.

aniket

ETF or Exchange Traded Funds and Index Funds are both passively managed funds. Both funds need not be actively managed by the Fund Managers and their returns closely track the benchmark Index. The benchmark Index in India is tracked by the BSE 30 and Nifty 50 which are the top companies in the country by market capitalization.

A few point of differentiation are given below:

1.      Index Funds can only be purchased at the end of the day whereas Index ETFs are available to buy or sell throughout the day at a price reflected by the Nifty 50.

2.      The expense ratio of an Index Fund is higher as compared to an ETF, but since an ETF is traded like a stock there are other factors that add to its cost such as-brokerage, STT and statutory charges.

3.      The tracking error risk is associated with both funds. Tracking error is the difference between the returns of the index fund and the benchmark index. This error is higher in the case of Index funds as compared to ETFs as Index funds need to keep larger cash balance to handle redemption requests, thereby reducing the effective rate of return.

4.      The dividend payout is another factor which is different between Index Funds and ETFs. In ETFs the amount of dividend gets directly credited into the investor's registered bank account. In Index funds you have the option of opting for a growth plan wherein your dividend is reinvested to purchase new units of the fund. ETFs need to perform this reinvestment manually.

I believe that Index Funds market in India is still at a nascent stage, and the readiness of Indian population to index funds cannot be ascertained. As an alternative, investing in Mutual Funds would prove to be the smarter investment. Prudent Mutual Fund managers have been consistently generating returns on actively managed funds. The added benefit of rupee-cost averaging exists which helps lower your average cost of owning units.

You can also read more details about Index Funds here. You can check out the top performing funds at Groww to invest in here.

Hope this helps!

Mutual fund investments are subject to market risks. Please read the scheme information and other related documents carefully before investing.
Past performance is not indicative of future returns. Please consider your specific investment requirements, risk tolerance, investment goal, time frame, risk and reward balance and the cost associated with the investment before choosing a fund, or designing a portfolio that suits your needs.
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