Which Should You Choose: ETF or Index Fund When Both Track the Same Index?

An ETF is a type of mutual fund that invests in a basket of assets such as stocks, bonds, or commodities. Most ETFs are “passively” managed and only track/ replicate the performance of their benchmark index. 
 

Usually, an ETF invests in the same companies and in approximately the same weightages as its benchmark. For example, 

• The Nifty 50 index tracks the performance of 50 of the largest companies listed on the National Stock Exchange (NSE), selected based on their free-float market capitalisation. 
• Now, a Nifty 50 ETF may replicate this index by investing in the same 50 companies, generally in the same proportions. 
   

Furthermore, unlike regular mutual funds, the ETF units are NOT purchased or redeemed at the day's Net Asset Value (NAV). Instead, they are traded on the stock exchange throughout the market hours, just like shares. 

Similar to an ETF, an Index Fund is also a passive vehicle. It also tracks the performance of a specific market index, such as the Nifty 50 or the Sensex. Instead of selecting stocks based on a fund manager's views, an index fund may invest in the same securities that are part of the chosen index, generally in the same proportions. For example, 

• Suppose an index fund tracks the Nifty 50 Index.
• Now, it invests in the same 50 companies that make up the index in similar weightages.
   

Depending on the benchmark followed, an index fund may invest in equities, bonds, or other eligible securities that form part of the index.

The investment objectives of both ETFs and Index Funds are to deliver potential returns that are similar to those of the underlying index, subject to tracking errors. Also, both are passively managed investments and replicate an index by investing in the same securities and in similar proportions. 
 

However, they differ in terms of how they are bought and sold, pricing, account requirements, costs, liquidity, and investment convenience. 
 

But what’s the primary difference? It is that ETFs trade on stock exchanges like company shares throughout market hours. They allow investors to buy or sell units at the prevailing market price.
 

In comparison, Index funds are purchased and redeemed directly through the mutual fund house, and their units are priced only once each business day based on the fund's NAV.
 

Additionally, some more key differences between ETF vs Index funds you should be aware of are:

When an ETF and an Index Fund track the same index (such as the Nifty 50 or Sensex), their potential long-term performance may be broadly similar, subject to tracking errors. 
 

Thus, the choice between ETF vs Index mutual fund is not about return potential. Instead, it depends on:

• How do you want to invest
• How often you transact, and the
• Level of convenience you prefer
   

Need a reference? You may refer to the points below:

So, now you know what ETFs and Index Funds are, how they differ, and which one you may choose when both track the same index. To summarise, both ETFs and Index Funds are passive investment options that may replicate the performance of a benchmark index. They invest in the same securities as the underlying index, in similar proportions. 
 

Now, if we talk about the differences, both these investment options differ as follows:

• ETFs trade on stock exchanges, while Index Funds are bought from the mutual fund house.
• ETFs have real-time market prices, whereas Index Funds are priced at the end-of-day NAV.
• ETFs require a demat and trading account; Index Funds do not.
• ETF transactions may involve brokerage and other trading charges.
   

The potentially “right” option? Since both aim to track the same benchmark, your decision should depend on “how you want to invest” rather than “what you want to invest in”. 
 

If you already have a demat and trading account and want the flexibility to buy or sell investments during market hours, an ETF may be a suitable choice. On the other hand, if you want to invest gradually through SIPs and do not wish to maintain a demat account, an Index Fund may be more appropriate. 
 

For more information, you can visit www.tatamutualfund.com/deshkarenivesh. The Investor Service Centre of Tata Asset Management Pvt. Ltd. is located at Mulla House, Ground Floor, 51, M.G. Road, Near Flora Fountain, Mumbai – 400 001, Maharashtra. The office hours are Monday to Friday, 9:00 AM to 5:30 PM. For assistance, you can also call (022) 6282 7777 from Monday to Saturday, 9:00 AM to 5:30 PM, or email service@tataamc.com

1. Is an ETF better than an index fund?

Realise that neither is inherently better! Both financial products may track the same benchmark index and deliver similar potential returns, subject to tracking errors. 

Thus, the potentially right choice depends on your investment preference: 

• If you already have a demat account and wish to invest lump sums, an ETF may suit you. 
• Whereas, if you don’t want to maintain a trading + demat account and are looking to invest gradually via SIPs, an Index Fund may be a potentially better fit.

2. Can I invest in an ETF through a SIP?

It depends on your stockbroker or investment platform. Generally, AMCs or brokers do not offer SIP facilities for ETFs. In contrast, SIPs are a standard feature of Index Funds.