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What is the difference between Index funds and ETFs?

Which of these are better? Should one buy index funds or ETFs instead of actively managed mutual funds?

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4 Approved Answers

Kavita Soni

Index funds are replica of an index. For example, HDFC Index Fund- sensex plan copies sensex. If the sensex is mde up of 25 stocks, so the index fund will buy these 25 stocks in the same proportion as they are in the HDFC index fund plan.

Index funds are passively managed funds wherein fund managers do not use their expertise to pick stocks. Instead they buy the stocks in the same proportion from an index that already exists.

The main difference lies in how the instruments can be purchased or sold. ETFs are traded on regular exchanges such as National Stock Exchange (NSE). They can be purchased like a common share via a broker or a trading platform. Hence investors can enter or exit the platform at any given point in time.

Index funds can be bought or sold via fund platforms too but they cannot be traded on exchange platforms. So in daily trading, investors can enter the market only one time a day at the NAV plus or minus a fee. This is done through creation or redemption of NAV units. The fee that is charged can be fixed or it might depend on the number of investors involved in buying and selling operations on the specific day.

ETF prices can be tracked ‘live’. For index funds, NAV is determined at the end of the day.

ETFs charge low expense ratio. Index funds have management expenses in addition to transaction costs.

Tanya

Index funds are passively managed funds that allow investors to participate in the stock market. These are constructed to track the components of a market index.

An ETF (Exchange Traded Fund) is a marketable security that helps track multiple assets such as an index fund. These trade like common stock on the stock exchange.

Main differences between the two are:

  • Expense Ratios- ETFs usually have lower expense ratios than index funds
  • Trading- ETFs trade intra-day, while index funds are traded at the end of the day
  • Flexibilty- ETFs offer higher flexibility than index funds
  • Ease of trading- Index funds are more easy to manage and trade when compared with ETFs
  • Minimum Investment- Index funds have a minimum investment limit of Rs.5000, whereas an ETF usually trades at 10% of the index value.

Mridul Agrawal

If you believe that Nifty and Sensex will scale new highs over the next three to five years and want to benefit out of investing in them, you can do so by investing in either Exchange Traded Funds (ETFs) or Index Funds. They are both passively managed funds, meaning they mimic the composition of the index and do not require active management on part of the fund manager and their returns closely track that of the benchmark.

Though both ETFs and Index Funds invest in securities comprising an index, they are not the same.

Following are a few points of differentiation:

(a) Minimum Investment: The minimum amount one can invest in Index Funds is Rs. 5000. An Exchange Traded Fund usually trades at 10% of the index value. Eg. If Nifty is at 5800, a Nifty ETF would cost about Rs. 582 roughly.

(b) NAV: The NAV of an Index Fund is decided at the close of every trading day. Because ETFs are listed on the stock exchange, their NAV is revised in real time depending on demand and supply forces.

(c) Liquidity: ETFs are more liquid as compared to Index Funds since they are listed on the exchange and are easily bought and sold.

(d) Expense RatioMutual Funds charge money for managing your funds. This involves the fund management fee, agent commissions, registrar fees, and selling and promoting expenses. All this falls under a single basket called expense ratio. The expense ratio for Index Funds typically ranges between 1-1.5% whereas for ETFs, it ranges between 0.5-1%.

(e) Transaction Costs: Index Funds are charged Entry or Exit Load wherever applicable. Brokerage and delivery charges are applicable on purchase and sale of ETFs.

(f) Tracking error: It is the difference between a portfolio's returns and the benchmark or index it was meant to mimic. Because some part of an Index Fund can be retained as cash to facilitate redemption, tracking error can be higher. Tracking error is lower for an ETF because transactions happen over the exchange and there is hardly any requirement of keeping cash for redemption.

(g) Investing Mode: Index Funds can be bought and sold from the fund or through authorized agents. ETFs are generally bought and sold through the market, though the investor also has the option to buy directly from the fund.

(h) Regular Investing: Regular Investing is possible in Index Funds through Systematic Investment Plan (SIP) wherein the investor's account is automatically debited at defined intervals of time. However, an investor needs to manually invest on a regular basis in an ETF.

aniket

Nifty and Sensex are indicators of market movement. Sensex, also called BSE 30, is an index comprising of largest 30 companies listed on the Bombay Stock Exchange (BSE) by market capitalization. Nifty or Nifty 50 is National Stock Exchange of India's (NSE) benchmark stock market index for Indian equity market. If the Sensex or Nifty goes up, it means that most of the stocks in India went up during the given period.


If you believe that Nifty and Sensex will scale new highs over the next three to five years and want to benefit out of investing in them, you can do so by investing in either Exchange Traded Funds (ETFs) or Index Funds. They are both passively managed funds, meaning they mimic the composition of the index and do not require active management on part of the fund manager and their returns closely track that of the benchmark.


Though both ETFs and Index Funds invest in securities comprising an index, they are not the same.


Following are a few points of differentiation:

(a) Minimum Investment: The minimum amount one can invest in Index Funds is Rs. 5000. An Exchange Traded Fund usually trades at 10% of the index value. Eg. If Nifty is at 5800, a Nifty ETF would cost about Rs. 582 roughly.


(b) NAV: The NAV of an Index Fund is decided at the close of every trading day. Because ETFs are listed on the stock exchange, their NAV is revised in real time depending on demand and supply forces.


(c) Liquidity: ETFs are more liquid as compared to Index Funds since they are listed on the exchange and are easily bought and sold.


(d) Expense Ratio: Mutual Funds charge money for managing your funds. This involves the fund management fee, agent commissions, registrar fees, and selling and promoting expenses. All this falls under a single basket called expense ratio. The expense ratio for Index Funds typically ranges between 1-1.5% whereas for ETFs, it ranges between 0.5-1%.


(e) Transaction Costs: Index Funds are charged Entry or Exit Load wherever applicable. Brokerage and delivery charges are applicable on purchase and sale of ETFs.


(f) Tracking error: It is the difference between a portfolio's returns and the benchmark or index it was meant to mimic. Because some part of an Index Fund can be retained as cash to facilitate redemptions, tracking error can be higher. Tracking error is lower for an ETF because transactions happen over the exchange and there is hardly any requirement of keeping cash for redemptions.


(g) Investing Mode: Index Funds can be bought and sold from the fund or through authorised agents. ETFs are generally bought and sold through the market, though the investor also has the option to buy directly from the fund.


(h) Regular Investing: Regular Investing is possible in Index Funds through Systematic Investment Plan (SIP) wherein the investor's account is automatically debited at defined intervals of time. However, an investor needs to manually invest on a regular basis in an ETF.

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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