Whether you are a new or seasoned investor, a key concept to consider for making good profits is the diversification of investments across and within different asset classes. Exchange-traded funds (ETFs) and index funds are good diversification options. They have various securities under one investment class, so they give you better companies exposures. Both funds offer the diversification, resulting in cost savings and solid long-term returns.
Still, ETF investment and index funds differ in certain respects. Understanding these differences will help you decide which to select as part of your diversification plan.
What is an ETF Investment?
ETFs are securities that track an underlying asset, including an index, commodity, or a mix of different asset classes. Some examples include Gold ETFs, Index ETFs, and Nifty 50 ETFs.
What is an Index Fund?
Index funds are open-ended mutual funds or ETFs that usually track the performance of a target index. This fund manager pools different investors’ money to build a portfolio of individual stocks/bonds/securities for diversification and maximising returns. Examples include the Nifty 50 Index and the Nifty 500 Index.
Difference Between ETFs And Index Funds
The key differences between ETF and Index Funds are:
|Type of Security||These funds are traded like stocks on any recognised stock exchange.||They are open-ended mutual fund schemes.|
|Trading Style||Purchased and sold over the trading day like stocks on any recognised stock exchange.||Brought and sold only at a price set at the end of the trading day.|
|Fund Management Style||Actively or passively managed||Passively managed|
|Investment||Lower investment than index funds as they bring in units.||Brokers place a minimum investment limit in place, which is higher compared to an average share price.|
|Investment Account||Only through the Demat account.||Physical or Demat Account.|
|Investment Type||Upfront investment with Systematic Investment Plans (SIPs) is not available.||Systematic Investment Plans (SIPs) are available.|
|Net Asset Value (NAV)||ETF NAV differs in real-time according to market fluctuations.||NAV is available at the end of trading day NAV available at the end of trading day.|
|Liquidity||Lower liquidity than index funds.||Highly liquid mutual funds.|
|Tax Benefits||More tax efficient.||Less tax efficient.|
|Costs||ETFs have a lower expense ratio than index funds but incur transaction costs while buying and selling ETFs.||Though expense costs are lower, they are higher compared to ETFs.|
|Tracking Mechanism||Lower tracking error implies ETFs can track indexes more closely.||Marginally higher tracking error owing to the high liquidity of these funds.|
ETF vs. Index Fund – Which is better?
The answer would depend on your investment goals, risk tolerance level, fund availability, and commitment to trading. For instance, if you have long-term investment goals, you must follow a disciplined investment approach. So, an index fund via the SIP route would be more suitable for you. Likewise, ETFs might benefit intraday traders in a highly volatile market.
Both ETFs and index funds help you achieve your investment goals through diversification. However, both these funds differ in certain aspects. For example, ETF investments provide lower expense ratios and better flexibility, which can be aptly traded during volatile market conditions. On the other hand, trading in index funds is easier and works well for investors looking for long-term wealth creation.
Disclaimer: This blog is not an investment advice piece. Trading and investing in the securities market carries risk. Please do your due diligence or consult a trained financial professional before investing.