The question of ‘Index Fund vs ETF – When to Choose One?‘ is an important one. Before diving to answer the question I would like to briefly discuss what the two are and the similarities and differences between them.
A Mutual Fund is an investment scheme. Lay investors who do not possess the required knowledge for making direct investments in stocks opt for mutual funds. An ‘Exchange Traded Fund (ETF)‘ is a special type of mutual fund and is listed on the stock market like any other stock and can be traded freely.
Index Fund vs ETF – Similarities
|Promoted by a Fund?||Yes||Yes|
|Actively or Passively Managed?||Passive||Passive|
|Assets Management Fees charged by the Fund||Low||Low|
|Tracks a Popular Index?||Yes||Yes|
|Is the Fund Divided into Small Units?||Yes||Yes|
Index Fund vs ETF – Differences
|Listed on a Stock Exchange?||No||Yes|
|Units Purchased From?||Mutual Fund, Directly||Mutual Fund, Directly first time when issued or on the stock market.|
|How Are Units Sold?||Redeemed from the Mutual Fund||Sold on the open market|
|How is the Unit Value Calculated?||Mutual Fund calculates and announces to unitholders at regular intervals.||Price reflected on the stock market minute to minute.|
|Liquidity||Slightly Less Liquid||Highly Liquid|
|Ease of Dealing||Slightly Difficult||Very Easy|
When to Invest in an Index Fund and When to Use an ETF?
I have invested only ETFs. I have invested in two ETFs as follows:
- NIFTY 50
- Junior NIFTY
These two ETFs in which I have invested in track the top 100 companies listed on the ‘National Stock Exchange (NSE)’ of India. I have not invested in an ‘Index Mutual Fund’. Why? Simply because I did not want to go through the hassle of calling up a mutual fund, wait for the representative to come, do the paperwork and so on. On the contrary, I bought the ETF units in an instant on the electronic stock trading platform in a fraction of a second. So what triggered my choice? Convenience, simply!
Income Tax Benefit
For that matter, I have not invested in any mutual fund at all until very recently. Why did I invest in a mutual fund recently? The reason is, in India certain types of mutual fund schemes are granted tax rebate. Under section 80 C of the Indian Income Tax Act, an investment in a special mutual fund scheme called the ‘Equity Linked Savings Scheme (ELSS)‘, up to Rs.1,50,000 can be deducted from the taxable income. This rebate is not solely for ELSS but it applies to many investment options including ELSS. Since real wealth can be created in the long run only through equity I decided to invest in ELSS.
Even though an ETF is also an equity-linked investment scheme the tax benefit is not available for investment in ETF in India. Therefore I had no other option but to invest in a mutual fund.
Please note, however, such a tax benefit may or may not be available in other countries.
I also want to inform my readers that even though it took a lot of time, visit of representative and paperwork for investment in the mutual fund for the first time, subsequent investments was quite simple and on-line on the mutual fund’s website. So, the so-called hassles of investing in mutual funds are no more relevant. Now the process has become quite easy and fast.
Fund Management Fees
Finally, we should see whether the management fee of an ETF is lower than that of a mutual fund. Of course, overall the management fees of both index fund and ETF are lower. But if an ETF scheme charges still lower fees, we should surely opt for an ETF.
I conclude by stating that virtually there is no debate of Index Fund vs ETF. Both are more are less the same. The ETF is relatively more convenient to deal with compared to an index fund.