What is the Difference Between Index Fund and ETF…!!
Investors these days invest in various types of financial instruments in order to diversify their risk and maximize return. Even investors in mutual fund invest in various funds to get better returns depending upon their style of investment, whether they are conservative, moderate or aggressive. In case, if anyone is a conservative investor then the Index fund is one of the best options to invest.
An Index Fund is basically a category of mutual funds, which imitate a market index. These funds purchase all the stocks in the same proportion as in an index. It means, that the scheme will perform in tandem with the index, it is tracking, save for a small difference known as tracking error. For instance, A BSE Sensex funds will invest in the top 30 companies appearing in the same proportions of the exchange.
But those who want to explore the market or having a better understanding of the market, then they can invest in the ETF. It’s quite liked the Index fund, basically a basket of securities which are held by the sponsored fund who issues the shares of the fund with keeping that basket of securities as underlying. The shares of ETF are traded on the exchange just like any other stock, including the opportunity to short sell or even purchase on margin. It can be in the form of bonds, commodities, currencies or equities. Let’s understand the difference between Index fund and ETF.
- ETF usually has lower investment minimum than index mutual funds, hence it has the lowest barrier to entry.
- In case, if you decide to purchase an index fund, it will get added in the assets under management (AUM) of that fund. But in case, if you purchase an ETF, it does not add to the AUM.
- The expense ratio of the ETF is much lower than the Index Fund. That’s mainly due to the fact, index funds are purchased and sold only on the exchange like other stocks. An investor will need to keep other fees and charges in mind such as STT and brokerage in mind.
- The investor of ETF can buy and sell shares on the open market throughout the day, whereas the index funds are traded once per day, after the market closes. So, investors have less control over the price at which they buy or sell shares.
- The risk in index funds is more prevalent than ETF as index funds require a higher cash balance for taking care of redemptions. Index fund requires a higher cash balance for redemption So, apart from the market risk known as beta, there is another risk known as the tracking error risk.
- An investor gets the dividends from ETFs into your registered bank account. On the other hand, one can choose a dividend reinvestment plan or a growth plan.
*Disclaimer: investment in securities market are subject to market risks, read all the related documents carefully before investing