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The beauty of mutual fund investments is that they can be rewarding if one is able to choose the right mix of securities and diversify their portfolio across various asset classes. Remember that mutual funds do not generate returns, they are an investment vehicle that allows investors to invest in a diversified portfolio of securities and various commodities, asset classes like gold, debt, real estate as well as in various sectors and industries like IT, pharma, crude oil, etc. Those who wish to generate returns by seeking exposure to international markets can invest in international mutual funds as well. With so many investment options available, sometimes making an investment decision can become a tad confusing especially if you are a first time investor.
Active funds like ELSS, large cap, liquid funds, etc. are quite popular among investors but a lot of investors are yet to explore passive investing through index funds and exchange traded funds. Today we are going to discuss passive funds and find out the difference between these two.
What are index funds?
While active funds have designated fund managers managing the portfolio and ensuring that it remains in sync with the changing markets, passive funds like index funds aim to generate capital appreciation by tracking the performance of its underlying benchmark like the NIFTY50, BSE30, S&P, etc. with minimal tracking error. The index fund manager invests in securities to match the portfolio of its underlying index.
What are exchange traded funds?
Exchange traded funds invest beforehand in their benchmark in the same way as their underlying securities are invested. ETF units can be traded live at the stock exchange just like company stocks. These mutual funds are listed on almost every index. The NAV (net asset value) of an exchange traded fund is determined by the volume at which they are traded during live trading hours.
Index funds v/s ETFs: What are the major differences?
| Parameters | Exchange Traded Funds (ETFs) | Index Funds |
| Net Asset Value (NAV) | The NAV of an exchange traded fund is available for investors at its current market price | The NAV of an index fund is determined at the of the day just like other mutual fund schemes |
| Liquidity | Investors can enter or exit ETFs at during live trading hours. They can buy or sell ETF units end number of times at the exchange thus offering high liquidity | One can either buy or sell index fund units by placing an order to the AMC. They aren’t as liquid as index funds |
| Intraday trading | Since ETFs are listed just like company stock, intraday trading is possible with ETF units | Index funds aren’t listed at exchanges and hence intraday trading is not possible |
| Cost efficiency | Every single transaction has brokerage fees as well as management costs | Only management costs are involved |
| Demat | One needs to open a demat account for storing their ETF units | Index fund units do not need demat account and can be stored in the regular mutual fund account |
| Portfolio management | Investors are responsible for managing their own portfolio | Fund managers offer passive management and investors get diversification |
While index funds can be ideal for those who wish to build a long term corpus by investing in a scheme that has very less scope for human error, exchange traded funds can be considered by investors who wish to indulge in intraday trading and understand how equity markets function.
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