ETFs vs. index funds – The Hindu

Suppose you decide to invest in passive funds for your goal-based investments.

You must first select a benchmark index and then choose an exchange-traded fund (ETF) or an index fund on that benchmark index. In this article, we discuss the factors that you must consider when deciding between an ETF and an index fund.

Total costs

Your choice of benchmark must be the large-cap index or the broadest investable index for institutional investors in the market where you make such goal-based investments. Take the NSE 500 Index. This index also contains mid-cap and small-cap stocks that can expose you to momentum crash.

That means these stocks can crash regardless of the direction of the market. This makes the choice of the broadest index somewhat risky for goal-based investments.

Suppose you choose a large-cap index. Then, you must decide whether to pick an ETF or an index fund benchmarked to that index. If you consider the base expense ratio (BER), an ETF is cheaper than an index fund; the median BER for an index fund is 0.15% compared with 0.08% for an ETF. But there are other costs to consider. You must set up a systematic investment plan (SIP) on an ETF through your trading account.

You can set up the SIP with market protection to ensure that your order is not executed at a price significantly greater than its last traded price.

If you are setting up the SIP for the number of units, then the amount debited each month will be different. If you set up the SIP for the amount, then you may have a residual amount in your account, as you cannot buy fractional units.

Suppose the ETF price is ₹61, and your SIP is for ₹10,000. Then, you will get 163 units, and ₹57 will remain in your trading account.

You will also incur demat charges and other costs such as SEBI turnover fees, brokerage commission and exchange transaction fees, including GST.

Index funds can allot fractional units. So, you can make use of your entire SIP amount. Also, you will not incur the other transaction charges.

Conclusion

The choice between an ETF and an index fund is more about preference than about cost. Note that ETFs can be sold in real time in the market, and the money is credited into your bank account the next day.

You must wait at least two days to receive the sale proceeds on your index funds.

(The author offers training programmes for individuals to manage their personal investments).