Indian investors have a plethora of options with respect to investing. Active investors can invest directly in stocks by opening a demat account with a SEBI-registered broker. However, there are crores of people in India who do not have the time to be active investors. So the best bet for them is to become passive investors and they have a few options like index funds and ETFs. Let us take a look at the difference between index funds and ETFs in this blog. 

What are Index Funds?

Index Funds are a type of mutual fund scheme where the scheme tracks and invests in constituents of indices like Nifty 50, Sensex, Nifty Bank, Nifty Smallcap 250, etc. 

These are open ended schemes which means you can invest in these schemes on any day and redeem on any day but at the end of day at net asset value (NAV). They have very low exit load or no exit load at all. 

The expense ratio of index funds is also very low compared to other mutual fund schemes. These are low risk investment schemes that are available for passive investors. These mirror the indices they track and there is no active selection of stocks by the fund managers of these schemes. 

What Exchange Traded Funds?

As the name suggests these funds are traded on exchanges and these funds also track various indices similar to index mutual funds. Since they are traded on the exchange, ETFs can be bought and sold like shares during the trading hours. ETFs have less expense ratio than index funds and no exit load, but have other charges like DP charges, SEBI charges, etc. ETFs are also a good option for low risk passive investors. Since they track the indices, the investment will be proportionate to the underlying asset allocation of the index. 

Difference between Index funds and ETFs

• Demat account: To buy and sell ETFs, you need a demat account. For Index Funds, you don’t need a demat account. 
• Investment method: ETFs can be bought from the secondary market and Index Funds can be bought from the AMC or any mutual fund platform. 
• Liquidity: ETFs have higher liquidity than Index Funds because they are traded on the stock market throughout the day during trading hours.
• Trading hours: ETFs can be traded during trading hours and Index Funds cannot be traded and there is no intraday trading possible with respect to index funds. 
• Pricing: ETFs price is determined by supply and demand in the market, whereas Index Funds are priced based on net asset value (NAV). 
• Expense ratio: ETFs have lower expense ratio than Index Funds. 
• Affordability: ETFs are bought and sold at market price on the exchange, whereas you can invest in one unit of Index Funds for as low as Rs 100. 
• Systematic Investment Plan: ETFs are traded like shares on the exchange, so you can pick a day in a week or a date in a month and invest regularly. Index Funds have a SIP option and mandate can be set for regular investments. 

Taxation

Investing in equity based index funds and ETFs attract taxes similar to investing in shares. So if they are sold within a year of buying them, the gains are taxed as per short-term capital gain tax which is 20%. If they are sold after a year of buying them, the gains are taxed as per long-term capital gain tax which is 12.5%. 

Conclusion 

For passive investors, index funds and ETFs are a simple and ideal way to invest and grow their wealth. Nonetheless, it is important to evaluate which financial instrument is appropriate and the selection must be based on affordability, risk tolerance, ease of use, and financial goals. If you want easy and instant buying and selling, ETFs are better than Index Funds.