Understanding the Differences Between ETF and Index Fund to Make Informed Investment Decisions.
The securities market comprises numerous investment instruments for all kinds of investors. You can invest actively and aggressively in equity securities to earn higher returns or choose passive, low-risk investments generating decent returns. Index Funds and ETFs are two such passive investment securities that seem similar but are inherently different. Read this comparison of ETF vs Index Fund to understand how they differ, starting with their definitions.
Exchange-Traded Funds or ETFs are a basket of securities traded like shares. These securities typically track specific stock indices such as the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE). ETFs constitute various types of instruments, including stocks, bonds, commodities, currencies, etc.
Categorised by SEBI as a type of Equity Mutual Fund, an Index Fund attempts to mimic stock market indices like BSE Sensex and NSE Nifty. In this type of investment, the Mutual Fund managers compose a portfolio as per the stock composition of the underlying index it attempts to replicate. The fund manager does not deviate from the benchmark index regardless of market conditions, which is why Index Funds are also known as passive funds.
The following are some of the significant differences between ETFs and Index Funds.
While an ETF attempts to track the performance of indices of specific exchanges like BSE and NSE, the Index Fund attempts to replicate the performance of that index.
Since Index Funds are not liquid on their own, they have a higher number of assets in cash and liquid securities than ETFs. As such, Index Funds are subject to tracking errors, which further causes them to deviate from the actual returns from the indices, they attempt to track. As for ETFs, the percentage of liquid assets and debts may vary from ETF to ETF, which is why returns may also go, even if the assets are under the same index.
You can purchase Index Mutual Fund units directly from Asset Management Companies by investing a lump sum or in instalments by opting for the SIP investment method. On the other hand, ETFs can be traded on the exchange, and you need a DEMAT account offered by banks and brokerage firms to invest in ETFs.
The expense ratio for Index Funds is slightly higher, typically in the range of 1per cent to 1.8 per cent. You also have to pay a fixed transaction fee of INR 100 for investments exceeding INR 10,000. The expense ratio is significantly lower for ETFs, i.e., 0.50 per cent, and you do not have to pay any recurring charges.
Comparing ETF vs Index Funds is essential as it goes to the heart of your investment objectives. While ETFs can help you create a significant corpus, ETFs too can help you achieve your long-term investment objectives. So make sure you choose wisely.
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*Disclaimer: This article is for information purposes only. We recommend you get in touch with your income tax advisor or CA for expert advice.