ETF vs Index Funds – What’s the Difference between the two?

ETF vs Index Funds: Investors today have a wide variety of investment vehicles available to them. However, as we know that increased options generally result in increased confusion.

Especially in matters of money. In the mutual fund industry, there are multiple investment vehicles. Today we will take a look at two important fund types ie, Index funds and Mutual funds in an attempt to differentiate them.



Table of Contents

  1. What is an ETF Vs Index Funds?

  2. Index Fund

  3. ETF

  4. Difference between ETF vs Index Funds

  5. 1. Demat Account Requirements

  6. 2. SIP Investments

  7. 3. Difference in Expenses

  8. 4. Valuation

  9. In Closing

What is an ETF Vs Index Funds?

Index Fund

To understand Index funds it is first important to understand what an Index is. In simple terms, an index is a collection of top securities that best represents a market or one of the market’s industries. The companies that are added to these indexes are done so by size i.e. by market cap.

The securities of the respective companies are then assigned weights based on their size. For example, the two most important indexes in the Indian stock market are the Sensex and the Nifty50. Take the Nifty50 for example. Here are the top 50 stocks by market cap. on the National Stock Exchange are included.

The biggest companies like Reliance and TCS make this index and hence receive higher weightage according to their size. But where does an Index fund come in here?

An Index fund is a type of mutual fund which only tracks this index i.e. they only buy and sell securities that are included in the index. In addition to this their composition of securities is also in the same weightage as that in the index.

These types of funds allow investors to reduce their risk as they generally include the best companies. And irrespective of market conditions their investments track the market benchmarks closely. These are known to provide good returns in the long run.

ETF

ETF or Exchange Traded Funds mostly operate in the intraday market. I.e.they buy and sell securities throughout the day and clock in profits from these trades when the market closes.

These funds are known for their transparency as investors are provided with information on the ETF’s investment and its unit price on a real-time basis. Some examples of ETFs are bond ETFs, currency ETFs, Commodity ETFs etc.

Difference between ETF vs Index Funds

Following are some of the differences between an ETF and an Index Fund:

1. Demat Account Requirements

A Demat account is required for an investor to buy and sell securities. In addition to this, an ETF is also required by an investor if he wants to buy ETFs. However, Index funds do not require the investor to have a Demat account. . 

2. SIP Investments

One of the major advantages of investing in mutual funds is that investors can do so in fixed auto-debit instalments i.e. SIP. This is also possible in Index funds. However, investors are not allowed to invest in an ETF through SIPs.

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3. Difference in Expenses

Mutual funds generally charge a service fee and commission from investors for their professional investment and management services. Investors are made aware of this through the fixed expense ratios. ETFs generally have a lower expense ratio than that of Index funds. But investors must keep in mind that index funds operate on an intraday basis and hence incur trading or transaction charges. 

4. Valuation

In this section, we mainly refer to the NAV or the cost of each unit of a mutual fund. The valuation is done continuously on an ETF allowing investors flexible trading options. However, the valuation of an Index fund only happens at the end of the day.

In Closing

Here we took a look at the differences between the two investment alternatives i.e. ETF Vs Index funds. Now that you know the differences, it will help you decide which is best for your portfolio. Let us know about your experience in dealing with ETFs and Index funds in the comments below. Happy Investing!

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