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What is the difference between ETFs and Index Funds?

People often get confused between both. Although Index mutual funds and Exchange traded funds looks similar but in the real term they differ in various aspect. ETFs and index funds are simply 2 different ways of investing in a similar portfolio of shares. Let me take you through the structure and transacting method.
Structure
ETF:
An ETF is made up of stocks making a particular index like Sensex or Nifty. Each of the stock would have the same weightage as it has on the index. Some portion of its assets may be held in cash or money market securities for liquidity purpose. Returns of an ETF are usually close to that of the index. However since the percentage of debt or liquid assets varies with ETF so does return from different ETFs thought they all track the same index.
Index Funds:
The portfolio of index funds also replicates a stock exchange index. Since index funds have no liquidity of their own, usually they have higher percentage of assets in cash and liquid securities than ETFs. Therefore this leaves for what is known in industry terminology as ‘tracking error’. Higher the tracking error, greater the deviation from actual index returns (in any direction).
Transacting
ETF:
ETFs as the name suggest, are bought and sold on the exchange. So you need a demat account for investing in ETF. Minimum one unit of the ETF has to be bought and it is done in the same way as shares are bought through a broker.
Index Funds:
These are mutual funds and units can be bought lump sum or periodically through SIP. Automating investment through SIP is a strong advantage you can get through index funds.
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Comments

  • Index Funds/Exchange-Trade Funds – Index Fund and ETFs invest in stocks in the same proportion as the underlying index. So a Nifty 50 Index Fund or ETF will aim to keep the weight of stocks inline with the Nifty 50 constituents. Thus, you get the wealth creation potential of equities at a lower cost. However, as the portfolio is passively managed, the returns may end up lower than actively managed equity funds. If you are not sure of the right actively managed a mutual fund, you can invest through SIP in an Index Fund.

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