Let’s say you have INR 10,000 and want to buy gold as an investment. The problem is this amount is not enough to buy a substantial amount of gold. In addition to the risk of price fluctuation, there is also an element of storage risk. Studying their historical performance, both ETFs and Index Funds have provided comparable returns.
Shareen, a 36-year-old investor, has been investing in mutual funds for a few years now. She recently read about ‘Index Fund’ and ‘Exchange Traded Fund or ETF’ that sounded similar to Mutual Funds. Questions like broker review the differences between Index Funds and ETFs, the similarities, and why they sound like mutual funds confused Shareen. Many mutual funds impose a penalty or fine on selling the shares before the fixed period.
INVESTMENT AWARENESS IN MILLENNIALS & THEIR INVESTMENT ACTIONS
ETF fee ratios can range from 1.5 to 2.25% below the actively managed fund expense ratios. Maintaining your financial health is one of the most important tasks, especially from a future perspective. Thankfully, there are multiple options that help you ensure that your money generates lucrative returns as per your goals.
- This gives the added benefit of rupee-cost averaging which lowers your average cost of owning the units.
- SIP has emerged as the most popular method of investing for retail investors.
- Update your mobile number & email Id with your stock broker/depository participant and receive OTP directly from depository on your email id and/or mobile number to create pledge.
However, unlike index funds, ETFs are traded on stock exchanges. In simpler terms, ETFs are index funds that are traded on the stock exchange. Moreover, the buying and selling of mutual funds happen directly between the fund and the investors. Also, the price of mutual funds is not determined until the NAV is determined at the end of the business day. While awareness about Exchange Traded Funds is quite low in India, these funds are gaining traction amongst investors over the last few years. In the last 5 years, the mutual fund industry assets under management in ETFs have grown at a CAGR of more than 100%.
What are the different types of index funds available in India?
For most investors looking at simpler solutions, passive funds offer the level of simplicity and returns which can match that of an index. Index mutual funds have no problem issuing shareholders partial shares. So if you want to invest $500 per month in an index mutual fund, you can be sure the entire amount will be fully invested. Index mutual funds have their own advantages, which will likely appeal to many investors.
Investors can begin investing a small portion of money in periodic intervals. Lower expense ratio due to lower transaction fees as compared to Index funds. Here, the investment is added to total assets under management.
The portfolio diversification comes through equity exposure which is mirrored to an index. Depending on specific financial goals and in the long run, both these can offer sustainable returns because they mirror the chosen index. An Exchange Traded Fund consists of a collection of securities that mostly follow an underlying index. These funds invest across industry sectors and may use various strategies.
Costs and Expenses
However, investing in ETFs requires trading and demat accounts and these costs add to the total cost of ownership, along with the expense ratio. In passive investing, investors don’t have to choose from over 5,000 funds that are available in the market. A lot of Indians have joined the investing bandwagon since the start of the covid-19 pandemic.
When you invest money in an Index Fund, the mutual fund company simply adds your funds to its AUM and then goes about its job of buying securities in line with the benchmark. And since the exact opposite happens when you wish to redeem in effect with Index Funds, there is no real concern on the liquidity front. On the other hand, Index Funds can be bought and sold only at a price published at the end of each trading day.
One of the most difficult decisions an investor must make when making any investment is choosing an option out of an ETF or mutual funds. ETFs are often freely traded on the stock exchanges, allowing you to purchase or sell them according to your needs. The market price for these shares may be seen in real-time just like regular shares. On the other hand, you must submit a request to the relevant fund houses in order to acquire or sell mutual funds. One of the most significant difference between ETF and Index Fund is in terms of where and how they are transacted. Index funds are sold at the end of the day like other mutual funds, while ETFs are traded on the stock exchange like shares.
His previous stints include ETMarkets, Reuters Bangalore and Press Trust of India. When investing in ETFs, retail investors don’t generally look at brokerage charges. Considering buy-sell brokerage plus the spread, investors might end up paying much more in ETFs than they would have paid for an index. For both index funds and ETFs, you should pick a fund with minimum tracking error. The tracking error is the divergence of an index fund from the index it is seeking to replicate. ETFs remove this limitation, as they can be bought at any point during the market trading hours.
ETFMirae Asset Nifty 50 ETF
Investors are made aware of this through the fixed expense ratios. ETFs generally have a lower expense ratio than that of Index funds. But investors must keep in mind that index funds operate on an intraday basis and hence incur trading or transaction charges. Since ETFs are traded on the stock market, in accordance with SEBI rules, you need a Demat Account held with some brokerage house. By completing the mutual fund KYC process, you can purchase Index Fund units from any authorised intermediary.
But ensure that you choose schemes carefully, taking note of the above-mentioned differences and its suitability to your investment objectives. In case of ETFs too, any dividend received by the fund is typically reinvested similar to td ameritrade forex review the growth option of mutual funds even though it does not have a growth or IDCW option. To achieve its target, passive funds invest in the same basket of securities that form part of the underlying index and in the same proportion.
Exchange Traded Funds or ETFs are securities that are traded, like individual stocks, on an exchange. Unlike regular open-end mutual funds, ETFs can be bought and sold throughout the trading day like any stock. Index funds or mutual funds invest in stocks that emulate a stock market index, such as the BSE Senses, NSE Nifty, etc. These funds are managed passively, and the fund manager invests exactly like the underlying index and in the same proportion to imitate the portfolio composition. Passive investing is the most basic form of putting one’s money in mutual funds and the purpose of this style of investment is to mirror the index and not beat it.
There is no stock selection in the index fund that the fund manager has to do. In this respect, investors are not at the mercy of the fund manager’s opinions, and advice. However, the fund manager can give investors the convenience of doing all the hard work. The only effort the fund manager puts in here is to ensure that the tracking error is kept at the bare minimum. The expense ratio of ETF is lower than that of index funds but there are additional costs to owning an ETF.
How to choose between ETFs and index funds?
Since ETFs and index funds are similar, you might have trouble picking the right passive investment vehicle for you. In the end, the decision boils down to one’s trading style. ETFs, much like stocks, trade intraday. They are a good choice if you want to take advantage of price movements within the day.
Index funds will be a better option if you are not concerned about seizing intraday opportunities. Moreover, while you need to be well-versed with the trading process if you want to trade ETFs, that is not necessary with index funds.
Because ETFs are continuously priced by the market, there is always a chance for trading to take place at a higher price than the actual NAV. Index funds are suitable for those investors who wish to invest in the equity market but are wary of the volatility of stocks. These mutual funds creates a portfolio which mimics given index. So these funds are expected give similar returns as per index. However, just like shares, ETF prices change real time throughout the day based on demand and supply in the market. Liquid ETFs invest in a basket of short term Government securities, call money or money market instruments of short term maturities.
What is the difference between ETFs and actively managed Mutual funds?
• In mutual funds, the AMC acts as counterparty to the investor. Investors do their buy / sell transactions with the AMC whereas ETFs are listed on stock exchanges like shares. Investors can buy or sell ETFs in the stock exchange at a real time price.
• Mutual fund NAVs are priced at the end of the day. However, just like shares, ETF prices change real time throughout the day based on demand and supply in the market.
• You can invest in mutual funds directly through AMC or through an AMFI certified mutual fund distributors (MFD). However, to invest in ETFs, it is mandatory to have a demat and trading account with a stock broker.
• ETFs do not aim to create alpha over the benchmark index that it tracks; it aims to replicate the returns of the benchmark index.
• Being passive funds, the ETF expense ratios are much lower compared to actively managed mutual fund schemes.
Overall, choosing between an Index Fund and an ETF is a matter of selecting the appropriate tool for the job. ETFs offer lower expense ratios and greater flexibility, while Index Funds simplify many trading decisions that an investor has to make. In most cases, these corrections of 3 odd percent are temporary, but it does not stop people from trying to take advantage of that.
Index mutual funds allow shareholders to reinvest their dividends automatically, commission free. ETFs don’t usually offer that service, and if they do, they’re less efficient. While both offer exposure to a broader market through passive investment, the operational differences between them can become the deciding factor for convenience sake. Just like when you want to travel from Mumbai to Goa, you could choose a train or an overnight bus. While both serve your end objective, the choice of one mode over the other for convenience is purely an individual choice.
In the table below, we explore the differences between index funds and ETFs. Simply put, the index fund is a basket of all the stocks included in a particular index with the same weight as their market capitalisation. The weight is balanced periodically to maintain nearly the same return as an index.