Want to invest, build a strong portfolio and watch your money grow but don’t want the hassle of picking individual funds? Exchange-traded funds (ETFs) and index funds could be the solution. These passive investments are well-known for their low costs, diversification benefits and index-tracking capabilities.
Of course, then comes the most important question, i.e., which option should you choose? Even though both are passive and overseen by professionals, they differ in how they are bought, sold and managed. Let’s break down the key differences between ETFs and index funds to help you understand how each can complement your investment strategy.
Trading and liquidity
ETFstrade on stock exchanges just like individual stocks. You can buy or sell them anytime during market hours at the current market price. This enables you to take advantage of intraday price fluctuations and improve returns. However, trading ETFs requires a demat and trading account.
Index funds are bought and sold directly through a mutual fund house at the Net Asset Value (NAV) declared at the end of the trading day. You cannot take advantage of intraday price changes, but it simplifies the investment process because you do not need a demat account. You need to be Know Your Customer (KYC) compliant.
SIP investments
Not all brokers offer a Systematic Investment Plan (SIP) facility specifically for ETFs, but many do. Index funds, however, provide a proper SIP facility across all fund houses. SIPs help you invest regularly with an amount as low as ₹500. They also average market volatility, promote financial disciplineand remove the need to time the market.
Expense ratio
Both ETFs and index funds have lower costs than actively managed mutual funds. However, when you compare them with each other, ETFs have lower expense ratios.
Since ETFs are traded like stocks, you will pay brokerage fees and other transaction costs each time you buy/sell, which can add up. Index funds don’t have brokerage fees but may have exit loads if you sell your units before a specific period.
Management style
Index funds follow a passive management style and track a benchmark index without active stock selection. On the other hand, ETFs come in two primary categories, i.e., active and passive, to meet diverse investor preferences.
ETF vs index funds | What should you choose?
Here is a table comparing ETFs and index funds so you can quickly decide which one best suits your investment style.
| Feature | ETFs | Index funds |
| Trading flexibility | Intraday trading available | Priced once a day |
| Demat account | Mandatory | Not required |
| Investment mode | Lump sum investment is the primary option, though some brokers offer SIP options | Both SIP and lump sum options are available |
| Expense ratio | Lower due to exchange-based trading | Comparatively higher |
| Liquidity | Higher, as ETFs trade on stock exchanges throughout the day | Moderate, as redemptions must go through fund houses, which process transactions once a day |
| Tracking error | Lower | Higher |
| Ideal for | Both passive and active investors | Passive, long-term investors |
To sum up
Both ETF and index funds are cost-effective, passively managedand offer diversification. Your final decision depends on your investment style, risk tolerance and liquidity needs. If you are a long-term investor who prefers a “set it and forget it” approach and wants SIP flexibility, you may find index funds beneficial. However, choosing ETFs may make more sense if you’ll capitalise on intraday price movements or require immediate liquidity.
That said, it is not about choosing one over the other. You can use index funds for consistent long-term growth while keeping ETFs for liquidity and adjusting your portfolio in real time.