December 29, 2020

What is Exchange Traded Fund (ETF) and Index Fund?

For major participants in stock market - passive investing is the most preferred way. When it comes to passive investing - two of the most preferred way is investing via Mutual Fund SIPs or ETF. In Mutual Fund, easiest way to take the most balance approach is via Index Fund. It becomes imperative to understand this passive approach little more before embarking on long term wealth creation journey. Let's just dive into the basics -

What are Index Fund?

In most simplified definition - Index Funds are mutual fund schemes that track an underlying index like Nifty or Sensex. Objective is to invest in the same stocks that builds the underlying index in the same proportion, to replicate the performance of the underlying index.

What are Exchange Traded Fund (ETF)?

ETF is like a closed ended fund, where funds are raised in the beginning and then the ETF creates a portfolio of stocks representing underlying index (Sensex, Nifty, etc). Once portfolio is made, no further  fresh applications or redemption requests are taken. However, the ETF mandatorily gets listed on the stock exchange so you can always buy and sell it like equity shares in the market and also hold it in your demat account. 

What are the advantages of investing via Index Fund or ETF?

  • Both ETF vs Index Funds allow diversification of risk as they follow the particular index, and not any particular company or sector or industry.
  • Both being passively managed, operating costs are lower

Index Fund vs ETF

So, now question is - what is better? ETF or Index Fund?

ETFs have the advantage of comparatively lower cost over index funds. However, index funds have more advantages in ease of transacting, buying and selling at will and no need to have a demat account. Ideally, cost is the biggest factor when investing in a passive fund but in India due to low awareness there is lesser liquidity in ETFs. Therefore, personally I prefer Index Fund as opposed to ETFs.

You can check the list of Index Fund at StockXplain site here

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