A thread explaining difference between ETFs and Index Funds.
What are ETFs and Index Funds?
Both are from the same family called passive funds, which mirror the index that they follow.
They both aim to track the performance of the underlying index as close as possible.
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What are ETFs and Index Funds?
Both are from the same family called passive funds, which mirror the index that they follow.
They both aim to track the performance of the underlying index as close as possible.
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What is the difference between Index Funds and ETFs?
The key difference is unlike index funds, ETFs are listed on exchange and one can invest at real time NAV.
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The key difference is unlike index funds, ETFs are listed on exchange and one can invest at real time NAV.
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How it works?
ETFs have a unique structure. There are 3 parties involved - AMC, Exchange and Market Maker.
Most retail investors can buy/sell ETFs on exchange, whereas large investors can invest through AMC also if they are investing large amount (usually above 50 lkhs)
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ETFs have a unique structure. There are 3 parties involved - AMC, Exchange and Market Maker.
Most retail investors can buy/sell ETFs on exchange, whereas large investors can invest through AMC also if they are investing large amount (usually above 50 lkhs)
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Index Funds are just like any other mutual funds when it comes to buying/selling.
There is no exchange or market marker involved. You simply have to approach the AMC to invest or redeem.
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There is no exchange or market marker involved. You simply have to approach the AMC to invest or redeem.
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What is the cost of owning them?
Just looking at expense ratio of an ETF or an Index fund is not enough.
You need to see following factors closely and then decide.
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Just looking at expense ratio of an ETF or an Index fund is not enough.
You need to see following factors closely and then decide.
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Tracking difference - Difference between index and the Scheme return.
Impact cost - The difference between actual NAV and the price at which you buy the units.
Eg: ETF NAV is Rs.100 but you buy it for 101 on exchange. Rs.1 is additional cost you pay to buy this ETF.
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Impact cost - The difference between actual NAV and the price at which you buy the units.
Eg: ETF NAV is Rs.100 but you buy it for 101 on exchange. Rs.1 is additional cost you pay to buy this ETF.
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Index funds do not have impact cost as you directly buy from the AMC and you get the units at actual NAV.
The other costs associated with ETFs are brokerage you pay while buying on exchange and demat maintainance cost.
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The other costs associated with ETFs are brokerage you pay while buying on exchange and demat maintainance cost.
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If the difference in the expense ratio of ETF and a similar index fund is not too high, then for most retail investors Index fund could be better as you don't have to incur impact cost and transaction charges while investing and redeeming.
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How to choose between an index fund or an ETF?
The confusion is natural, as both are passively managed investment vehicles designed to mimic the performance of other assets.
Following points may help decide.
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The confusion is natural, as both are passively managed investment vehicles designed to mimic the performance of other assets.
Following points may help decide.
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Then why ETFs are more preferred in US?
ETFs are more popular in US and some developed markets for specific reasons.
In these markets, ETFs are more tax efficient as gains are incurred only when you buy/sell ETF units and you pay tax only on when you sell ETF units.
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ETFs are more popular in US and some developed markets for specific reasons.
In these markets, ETFs are more tax efficient as gains are incurred only when you buy/sell ETF units and you pay tax only on when you sell ETF units.
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While in Mutual Fund structure, gains arise even when mutual funds trade and when these gains are transferred to investors every year they attract taxes.
This is not the case in India. Taxation in ETFs and Index Funds – which are akin to Mutual Funds, is the same.
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This is not the case in India. Taxation in ETFs and Index Funds – which are akin to Mutual Funds, is the same.
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In developed world the expense ratio is usually lower in ETFs than in Index Funds.
In India however, you get both structures at almost same expense ratios.
Keep these points in mind if you are confused between choosing an ETF or an Index Fund next time.
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In India however, you get both structures at almost same expense ratios.
Keep these points in mind if you are confused between choosing an ETF or an Index Fund next time.
12/end
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