Investors who wish to invest in mutual funds with a lower expense ratio, have 2 broad choices to choose from. You can choose to invest in index funds or Exchange Traded Funds (ETFs) according to your investment portfolio. This article aims to be a mutual fund investment guide in choosing the right low-cost mutual funds for you.

Index funds vs ETF

The following table summarieses the differences between ETFs and index funds.

Parameter ETF Index fund
  ETF is similar to mutual funds and comprise of stocks that make up indices such as Sensex or Nifty These stocks bear the same weightage as they do on respective indices. As the allocation of debts and liquid assets vary from one ETF to another, the returns from each ETF might also differ even if they are belong to the same group of index. Index Fund portfolios aim to duplicate stock market indices. They do not have liquidity on their own. This is why index funds have more number of assets in cash and in liquid securities as opposed to ETFs. As a result, index funds are often subject to tracking error that might cause them to diverge from the actual returns from stock market indices.
  ETF can be used to serve long-term investment goals and trade strategies. Index funds are mainly used to collect a savings corpus for long-term wealth creation or to support a post-retirement fund
  ETFs require a minimum lumpsum investment of Rs. 10,000. Investors cannot opt for an SIP investment in case of ETFs The minimum investment amount for index funds is Rs 5000 in case of a lump sum investment or Rs. 500 in case of an SIP investment (systematic investment plan)
  ETFs are bought and sold on a exchange. The investors are required to have a DEMAT account to do the same. Investors need to buy units of ETF through their Demat account via a broker, similarly to how shares are traded in the market Index funds are types of mutual funds whose units can be bought via lumpsum or SIP mode of investment. Investors who automate their investments in index funds through SIP can avail the benefit of a disciplined investment
  ETFs do not impose any recurring charge. These funds only levy a maintenance charge of 1% on the Demat account and a minimal transaction charge of 0.5% Index funds impose a minimal expense ratio anywhere between 1% to 1.8%. Additionally, investors have to pay a fixed transaction fee of Rs. 100 for every investment over and above Rs. 10,000.
ETF has a 3 day settlement period
Index Funds have a 1 day settlement period
  When it comes to tax efficiency between ETFs and index funds, ETF can have a lower tax liability. They are taxed according to the tax implications of their underlying assets. For example, if an ETF has stock holdings, it will be taxed based on the tax liabilities of stocks. The units redeemed from index mutual funds fall under an investor’s capital gains. The taxation of these gains depends on the holding period of the respective funds. Taxes are charged conferring to the applicable rates on long-term capital gains (LTCG) and short-term capital gains (STCG)

Whether you choose to invest in index funds or ETFs, ensure that your funds objectives are in line with your financial goals, risk appetite, and investment horizon. Happy investing!