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Investment needs time, effort, and understanding of the instruments. If one lacks any of these, an alternative can be to invest passively. This is where passive investment streams such as Index funds and ETFs come to the forefront to help investors benefit from rewards with the assistance of professional fund managers. In this article, we will look at the distinct features of index funds and ETFs and Index Funds vs ETFs comparison.
What are index funds?
Index funds are like mutual funds where investors invest in securities that are further diversified into commodities, shares, and bonds.
The index funds are similar to popular indices like Sensex 100 and Nifty 50. This helps investors in two ways, they can make investments in risky shares while minimising the risks since the index fund ensures that the investment stays above the benchmark irrespective of the market conditions.
Index funds provide investors with a good long-term funds investment opportunity that makes it a common passive investment option. The main characteristics of index funds are that they are open-ended mutual fund schemes where investments can be invested and redeemed at any time.
They have both growth and dividend options that allow investors to make an investment based on their risk-taking capacity.
What is ETF?
Exchange Traded Funds or ETFs comprise funds traded in the intraday shares market where the profits are clocked at the end of the day. ETFs provide a transparent source of investment where the investors can see exactly where their investments are allocated.
Similar to index funds, the ETFs are also affected by the share market. Common ETF examples include industry ETF, commodity ETF, bond ETF, inverse ETF, currency ETF, etc.
The main characteristic of ETFs is that the dividends earned from investments in ETFs can be reinvested in the share market. The investors also get a regular intimation of their investments and the funds can be invested and redeemed at any time.
Comparison: ETF vs index fund
With knowledge of what both these funds are, let us look at the key differences between the two:
- Demat account
Trading in index funds requires investors to have a Demat account as they are traded just like the share market while there is no such mandatory rule for ETFs.
- SIP investment
There is an option to invest in index funds via SIPs lock-in-period or till the time the child turns 18. As against this, investors can’t invest in ETFs via SIP.
- Expense ratio
Another factor that determines the ETF vs index fund investment choice is the expense ratio. Index funds have a higher expense ratio when compared with ETFs.
- Fund management
The index funds are mostly managed by fund managers. As against this, ETFs have a relatively more flexible fund management system.
- Funds valuation
In Index funds, the valuation of funds takes place at the end of the day. On the contrary, there is a continuous fund valuation in ETFs.
- Investment amount
Investors can buy one or more units of ETFs in the stock market and thus, the minimum investment amount equals the price of one unit. As against this, the minimum amount of one-time purchases and additional purchases is determined by the Scheme Information Document for index funds.
- IDCW
The index funds have Income Distribution cum Capital Withdrawal options that are determined in the SID. Investors can choose which option they wish to invest in based on their requirements. As against this, ETFs do not have any IDCW options.
- Tax savings
ETFs are considered more tax-friendly when compared with index funds. This is because when investors sell an ETF, they are selling it to another investor and the money comes directly from them.
The capital gain taxes are the investor’s to pay in this case. As against this, in the case of index funds, they must be redeemed with the fund manager to cash them.
When a fund is sold, the capital gains are passed on to every investor which means that they might have to pay capital gain taxes without even selling a share.
Conclusion
ETFs and index funds both provide investors with an extraordinary opportunity for passive fund investment while also giving them the benefit of having the securities managed by professional fund managers. Both these securities come with distinct features that must be carefully considered before investing in either of them.
While ETFs provide higher profits, index funds provide a higher degree of security. As a result, all investors must carefully determine their goals before making an investment decision. To learn more, subscribe to StockGro blogs.
FAQs
Index funds are more common than ETFs because of the higher degree of security that they provide all investors.
The difference between ETF and index funds is that ETFs provide relatively better profits to the investors while index funds guarantee more security. While both of these are passive investment opportunities, mutual funds are more actively managed and aim to outperform the market benchmarks.
ETFs are more transparent and flexible funds that also provide a larger tax benefit. As against this, index funds are less transparent, and flexible and come with more tax implications.
The investor’s risk is more divided in the case of index fund investments as compared with ETF options.
When looking from a security angle, index funds are a relatively more safe option for investors. As against this, ETFs are better for faster growth.