Investing in mutual funds can sometimes get a little tricky because you have to choose from different types of mutual funds and analyze the right mix of diversification of stocks in each mutual fund. In today’s time, thinking about returns for etf vs index funds is inevitable.
These two passively managed financial instruments replicate the performance of an underlying index and provide an in-built diversification in stocks but still, there are many differences between these two funds in terms of their functionality.
After reading this blog, you’ll understand the meaning of ETFs and index funds and you can find out the details on ETF vs index funds.
What Are ETFs?
ETFs are market-tradable instruments that track a particular index such as Nifty 50, Nifty 100, etc.
These passive instruments try to replicate the performance of the underlying index and invest the money into the stocks in the same weightage listed on the index.
The prices change in real-time throughout the trading day on a stock exchange, reflecting the market demand and supply. You can buy or sell these funds at the current market price.
There are different types of ETFs such as equity ETFs, currency ETFs, Bond ETFs, commodity ETFs, sectoral ETFs, and international ETFs.
ETFs are suitable for investors who want to get the benefit of diversification in their portfolio and want to earn the same returns as the underlying index. Also, those who prefer liquidity can invest in ETFs.
What Are Index Funds?
Index funds are the types of mutual funds that track the performance of an underlying index.
In these passive mutual funds, the fund manager buys the stocks in the same weightage and is changed only when the composition or stock changes.
These passive mutual funds do not generate the same returns as those generated by the underlying index because of the tracking error.
This arises because of the different charges applicable to the management of these funds such as transaction charges, advertising costs, etc.
The lower expense ratio of these funds, compared to any other actively managed mutual funds such as equity funds, stems from the fund manager’s limited involvement in stock selection.
Index funds are suitable for investors who are new to the stock market investing and want to invest in different stocks at the same time to lower the overall risk.
ETF Vs Index Funds: Key Differences
Here are the main differences between ETFs and index funds:
| Points of Differences | ETFs | Index Funds |
| Pricing | ETFs are priced like stocks and their price changes throughout the trading day. | Index funds are priced on the basis of the NAV (Net Asset Value) which is disclosed at the end of the day by the AMC. |
| Listing on the Stock Exchange | ETFs are listed on the stock exchange. | Index funds are not listed. |
| Liquidity | They are easy to buy and sell anytime at the current market price. | Index funds are only bought and sold at the NAV according to the cut-off timings. But surely you can sell the units very easily. |
| Need of a Demat account | You compulsorily need a Demat account to hold the ETF certificates. | A Demat account is not a compulsion to invest in index funds. |
| Availability | You can find the list of ETFs on the stock exchanges and invest them like a stock. | You can search for index funds on the mutual fund house’s website or the stockbroker’s website such as Dhan. |
| SEBI Rules | ETFs are required to invest at least 95% of their assets in stocks of a particular index. | The rule for minimum percentage is the same for index funds which is 95%. |
| Analysis Required | You can analyze the ETFs continuously because its price changes on a real-time basis. | You can choose not to analyze index funds continuously because their NAV does not fluctuate in every second. |
| Intraday Trading | ETFs can be traded like a stock for intraday trading. | Index funds cannot be used for intraday trading. |
| Arbitrage | ETFs can be used for arbitrage between cash and futures markets. | Index funds are not used for arbitrage purposes. |
| SIP or Lumpsum | You can buy the ETF in quantity as the way you buy a stock. Dhan offers you the option to invest in ETFs through SIP. | You can invest in index funds either through SIP mode or lump sum. |
| Presence of Tracking Error | Tracking error is present in ETFs. | Index funds are exposed to a tracking error. |
Conclusion
ETFs and index funds both are passive funds and try to replicate the performance of an underlying index.
At the stock exchange, investors trade ETFs, but they do not trade index funds.
Fund houses reveal the index fund’s NAV at the end of the trading day. The ETF’s price changes throughout the trading day.
📌 You can also read:
- ETF Vs Mutual Fund: Which Is Better?
- Are ETFs Good For Beginners? Guide to Invest in ETFs in India
- What are ETFs – How do Exchange Traded Funds Work?
Happy Investing 💰
Note: This blog is not to be construed as investment advice. Please do your own due diligence when investing in mutual funds. The mutual funds mentioned above are examples, not recommendations.
