Have you ever thought of investing your money in the funds like ETF and index fund? As both are collective investment tools, people get frequently confused amidst the two investment vehicles. Nevertheless, they are different in the sense that an Exchange Traded Fund (ETF) is a kind of Index fund which is a basket of securities traded on an exchange. But an index fund is a form of mutual fund, which attempts to track the performance of a specific index.
Since last few years, the stock market has gained immense importance, especially among investors. The most attractive feature of these funds is that they provide better returns, for your money. So, take a glance at this article, to completely understand the differences between ETF and Index Fund.
Content: ETF Vs Index Fund
Comparison Chart
| Basis for Comparison | ETF | Index Fund |
|---|---|---|
| Meaning | A fund that tracks indexes of an exchange and traded like other stocks is an Exchange Traded Fund or ETF. | An investment fund that tries to replicate the performance of a benchmark market index, is known as an index fund. |
| What is it? | Form of Index fund | Form of mutual fund |
| Trading | On an exchange. | Units can be purchased in lump sum or at regular intervals through SIP. |
| Pricing | Throughout the day. | At the end of the day. |
| Basis of pricing | Demand and supply of the security in the market. | NAV of the underlying asset. |
| Orders | Manual | Can be automated |
| Flexibility and liquidity | High | Low |
| Trading fees | High | No |
Definition of ETF
When an investment vehicle, incorporates the characteristics of an index mutual fund and a stock, such a hybrid product is known as ETF or Exchange Traded Fund. It is a basket of stocks representing indexes like Nifty or Sensex. These are also known as index shares. They are listed on an exchange and traded all the day like any other stocks. Their prices are linked to the indexes of the stock market.
The product was first developed in the United States in 1993 and later on introduced in India in the year 2002. Order placement is quite simple in ETF, as it does not involve any paperwork. ETF products that are normally found in the markets include Index ETF, Bond ETF, Currency ETF, Commodity ETF.
Definition of Index Fund
Every stock market has an index that identifies the movements of a part of or the whole stock market. A mutual fund or exchange traded fund with a portfolio, designed to track the returns of a specific market index such as the BSE Sensex or CNX Nifty. These are low-cost funds that affect the whole market.
In short, an index fund is a passive investment tool that is structured to maintain the portfolio of all securities in the exact proportion as specified in the benchmark index. Therefore, if the value of index falls, the value of the fund’s shares also goes down, and when the index rises, the value of the fund’s shares also goes up. In this way, an investor will earn the same returns as earned by the market.
Key Differences Between ETF and Index Fund
The difference between ETF and Index Fund can be understood clearly with the following points:
- The ETF is defined as a fund that tracks a stock market index and traded like ordinary stocks. An index fund is an investment vehicle which tracks the performance of the benchmark market index.
- The ETF is nothing but a type of index fund while index fund is a mutual fund.
- ETF’s are traded on an exchange. On the other hand, direct investment in an index fund is not possible, but actually, a mutual fund or an ETF traces indexes. So you can buy a mutual fund or ETF that can either be purchased in a lump sum or at regular intervals through Systematic Investment Plan (SIP).
- ETF’s are priced throughout the trading day. On the other hand index funds are priced, at the close of the trading day.
- Pricing of an ETF is based on demand and supply of securities in the market. Conversely, an index fund is priced as per the Net Asset Value (NAV) of the underlying asset.
- In ETF only manual orders are placed i.e. you need to sign in to place the order while in the case of an index fund, you can automate your investment through SIP.
- The flexibility and liquidity are comparatively higher in ETF than in an index fund.
- The trading fees of an ETF is high. As opposed to an index fund, where there are no trading fees.
Conclusion
After reviewing the above points, it can be said that there are a number of similar aspects like both are passively managed investment vehicles and both tries to trace the index. But, it cannot be ignored that they are not one and the same thing. If you are a novice in the stock market and want to invest in one of these two schemes, then you can make a choice considering the differences. Furthermore, a retail investor opts index fund rather than an ETF because they are cheaper and simpler. But an institutional investor chooses ETF, because of its several benefits like tax efficiency and stock-like features.
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