Difference between Exchange Traded Funds (ETF) and Index Funds

Many people use Exchange Traded Funds and index funds synonymously. Purely from the standpoint of investment objectives, index funds and exchange traded funds (ETFs) are very much the same. Exchange Traded Funds (ETFs) like Index Funds invest in a basket of stocks which replicate the index. Like Index Funds, Exchange Traded Funds (ETFs) are passively managed and aim to track the index. While there are similarities between the two types of funds, there are differences between the two which investors should clearly understand.

Read what are Index Funds

Exchange Traded Funds (ETFs) have hybrid characteristics of both stocks and mutual funds. Exchange Traded Funds (ETFs) can be bought and sold only on stock exchanges. Investors should have demat and share trading account to invest in Exchange Traded Funds (ETFs). However, investors do not need a demat account and share trading account to invest in index funds. Net Asset Values (NAV) of Index Funds are priced at the end of the day like any other mutual fund scheme, while ETFs are like stocks where the price changes on a continuous real time basis.

Investors can take advantage of intraday volatility (buying at the low point of the day and selling at high point of the day) in ETFs. Like any other mutual fund scheme, you can invest in index funds through Systematic Investment Plan (SIP) too. However, you cannot invest in ETFs through Systematic Investment Plan. Exchange Traded Funds cost less (as they have lower expense ratio) than Index funds.

Exchange Traded Funds (ETFs) and Index Funds serve the same investment objectives. If you have demat and share trading account, you can invest in Exchange Traded Funds (ETFs) if you prefer lower expense ratios. However, if you do not have a demat and share trading account then you can achieve the same objectives by investing in index funds like any other open ended mutual fund scheme.