What are the major differences between Index Funds vs ETFs?

What are the major differences between Index Funds vs ETFs?

While both Index Funds & ETFs are similar in their function, they tend to differ in operational and execution characteristics. ETFs as their name suggests are traded on their exchange in real time whereas Index funds like typical mutual fund are not. Both seek to track and replicate their benchmark index but have distinct differences which appeal to various types of investors. Here are a few aspects where they differ:
  1. Intraday Market Movement: ETFs as their name suggests are listed and traded on the exchange allowing investors to enter and exit anytime during the trading hours thus capitalizing on intraday moves. Index fund units are not listed on the exchange and thus cannot be traded making entry and exit possible only at the end of the day with the fund house.
  2. Net Asset Value (NAV): Official NAV for index funds and ETFs is calculated at the end of the day like any other mutual fund using closing prices announced by NSE/BSE. However in case of ETFs a real time NAV during live market hours is calculated which known as Indicative NAV or iNAV. The Indicative NAV (or iNAV) accounts for current price movements during the day to get as close to a real time NAV value as possible.
  3. Cost Effectiveness: Index Funds and ETF generally tends to have low expense ratio as compared to active schemes. Between index funds and ETFs, ETFs may appear to be cheaper than index funds in terms of expense ratio; however it is worth to note cost outside expense ratio incurred by ETF investors which includes bid-ask spread over iNAV, brokerage, exchange fees and other transaction costs while buying and selling ETFs.
  4. Liquidity: Liquidity for an index fund is provided by the respective fund house or asset management company. Not all ETFs are liquid, hence fund house usually appoints market makers whose mandate is provide quotes on both bids and offers to help investors easily enter and exit ETFs, in addition large ETF investors can buy/sell units directly with fund house.
  5. Portfolio Disclosure: Index funds and ETFs both disclose their portfolios on a monthly basis wherein along with stocks and their weightages. In case of ETF, as per regulatory requirement it is mandatory to publish a form of portfolio disclosure called ‘Creation Unit’ everyday, which includes latest portfolio holding along with weights. A creation unit is a block of new shares created by a fund house as an issue to a large investor or to market maker for sale in the open market.
  6. Storage of units: ETFs are treated like stocks and thus are compulsorily held in a dematerialized form using a demat account. Mutual Fund units can be held in a demat account but are typically held by the fund house itself in a sort of pool account.
  7. Other aspects: ETFs are generally preferred by institutional investors due to sheer size and long term investment horizon, whereas index funds are generally preferred by retail investors for a hassle free experience.
In summary, ETFs are better suited for investors who are looking for intra-day pricing, holding in Demat format, and entry and exit via brokerage platforms. Equivalent Index Funds are better suited for investors who are looking for long-term allocation, end-day NAV pricing, and holding in non-Demat format. 


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