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Summary:Though both are passive in nature, ETFs (exchange-traded funds) and index funds differ in many ways. We break down their differences and tell which is the better option for first-time investors.
ETFs (exchange-traded funds) and index funds share a common approach: they both passively invest in an index, such as the Nifty and the Sensex. They simply buy the stocks in the same proportion present in the index they are investing in.
However, while ETFs are bought and sold like stocks from the stock market, index funds operate like any other mutual fund.
This is the subtle difference between them. And because they differ in the way they operate, they are suited to different types of investors.
Here, we examine the key differences to help you make an informed decision.
ETFs vs Index funds: Key differences
|
|
ETFs | Index funds |
|---|---|---|
| Ease of investment | As mentioned earlier, these funds trade on stock exchanges and must be purchased each time manually. You cannot set up SIPs for ETFs. | You can invest in index funds through SIPs, allowing for systematic monthly investments. |
| Pricing | Like stocks, ETF prices are updated in real time throughout the trading day. However, ETFs may trade at a premium or discount to their net asset value (NAV), depending on supply and demand. | The NAV of index funds is calculated daily. Thus, you are assured of receiving the required units at the NAV, with no price fluctuations. |
| Liquidity | Depends on the demand for ETFs. For instance, ETFs tracking major indices such as the Nifty or Sensex are more liquid than those tracking niche indices. | Liquidity is not an issue, as the fund house handles all purchases and redemptions directly. |
| Cost effectiveness | ETFs usually have lower expense ratios than index funds, making them more cost-friendly. | Expense ratios of index funds are typically higher than for ETFs. |
| Account requirements | To invest in ETFs, you need to have a demat and trading account. If you don't have one, you'll incur additional account maintenance charges. | Investors don't need a demat or trading account to invest in index funds. |
Who should invest in ETFs?
Investors who are cost-conscious: ETFs typically have lower expense ratios, making them more cost-effective.
Investors with a demat account: Investors who already have a demat or a trading account might find ETFs a better and more straightforward choice over index funds.
Who should choose index funds?
Novice investors: If you are a first-time investor or new to investing and prefer a hassle-free approach, index funds can be a good starting point, owing to their simplicity and straightforward approach.
SIP enthusiasts: If you prefer the convenience of automated, consistent monthly investments, consider index funds.
Investors without a demat account: If you don't have a demat or trading account, index funds are ideal.
Flexibility of withdrawal: Unlike ETFs, whose availability depends on demand-supply factors, index fund units can be redeemed at any time from the AMC directly.
Fund of funds (FoFs): Another way to invest in ETFs
If you are keen on investing in ETFs but don't have a demat account, you may consider investing in a fund of funds (FoF). These mutual funds invest in ETFs or any other fund, giving you indirect exposure to them.
However, keep in mind that with FoFs, you will incur dual expenses: those of the FoF itself and those of the underlying ETF.
Our verdict
So, which is the right option for beginners?
If you are seeking a low-cost investment option and have a demat and a trading account, ETFs are often better.
However, for beginners looking at convenience and discipline, index funds are ideal. Additionally, they can also be a cost-efficient way to build wealth over time, especially when you compare them with an active large-cap fund
If you are exploring index funds and ETFs in the large-cap space, Value Research Fund Advisor can offer expert insights and tailored recommendations to help you build a strong, diversified portfolio effortlessly. Start your journey to smarter investing today.
Also read: ETFs or index funds: Which to choose for wealth creation?
This article was originally published on December 23, 2024, and last updated on December 17, 2025.
Disclaimer: This content is for information only and should not be considered investment advice or a recommendation.
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