Investors in India are now keenly searching for passive investments, this trend is gaining traction as the short term equity market returns are starting to wane due to consistent Foreign Institutional Investors (FII) selling.
That is why it will be reasonable to know what Index Funds and Exchange-Traded Funds (ETFs) are and what are several important differences between them.
Further, though they both invest aiming to replicate the performance of definite market indices. While in objectives they are almost identical, regarding form, trading mode, and price, they differ as much as chalk and cheese.
Most crucial differences to keep in mind are provided below:
Trading mechanism
ETFs are traded on the share market like shares, and they may be bought or sold during the day at prevailing market prices. Index Funds are traded just once in a day when the share market is closing, and hence the trade is on net asset value (NAV) basis at the closure of the share market.
Flexibility in investments
Investors can make use of intraday price variations with the help of ETFs, so they are appropriate for the investors who are ready to make use of price variations. Index Funds are not as flexible in this context. They can be sold or bought only at the close of the trading day therefore, missing out on real time trading.
Demat account requirements
To invest in ETFs, one needs to have a demat account as these funds are listed and traded on a stock exchange. Index Funds do not need a demat account, thereby becoming a convenient option for an investor who does not want to have an indirect mutual fund investment scheme. Hence, if you wish to not participate in the markets directly and do not wish to open a demat account then you can consider index funds.
Systematic Investment Plans
Investors can invest in Index Funds under Systematic Investment Plans (SIPs) whereby they can invest a small sum every now and then for a stated period of time. This cannot be made possible in most situations for ETFs, and this may discourage some investors from using a systematic investment plan.
Expense ratios
Usually, ETFs are cheaper than Index Funds as they follow a passive management strategy and operational expenses are minimal due to the same. This is the key reason ETFs are the most preferred among long-term investors who do not want to spend on fees but would like to have exposure to market indices.
To conclude, both ETFs and Index Funds are excellent passive investment vehicles in India. Both of them have their pros and cons. Which one to choose, though, is a function of investment style, liquidity requirement, and overall investment objectives.
This is what will assist investors in making informed investment decisions based on basic investment concepts and differences between ETFs and Index Funds. Further, if in doubt always take professional advice from a SEBI registered investment advisor.
(Disclaimer: ETF and Index Fund investments are subject to market risks, read all scheme related documents carefully.)
