Free tools · Guide · 4 minute read

ETF vs index fund

Both hold the same shares in the same proportions as an index. The difference is in how you buy them, and that decides which one fits you.

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Side by side

ETFIndex fund
What it holdsThe indexThe same index
Where you buyOn the exchange, through a brokerFrom the fund house, at the day's NAV
Demat accountNeededNot needed
Expense ratioUsually a little lowerUsually a little higher
Other costsBrokerage and the bid-ask spreadNone on most index funds
Price against true valueCan trade above or below NAVAlways NAV
Monthly SIPOnly where a broker offers it, in whole unitsBuilt in, with fractions of a unit
SellingNeeds a buyer on the exchangeThe fund house always buys back

The same portfolio, two ways in

A Nifty 50 ETF and a Nifty 50 index fund own the same fifty companies in the same weights. Neither has a manager choosing shares. Many index funds are simply a route into the same fund house's ETF.

So this is not a choice between two investments. It is a choice between two ways of holding one.

Where an ETF comes out ahead

  • Yearly cost. ETFs on the main indices have some of the lowest expense ratios available.
  • Buying at a moment of your choosing. You see the price and trade at it, during market hours.
  • Large amounts. On a big, liquid ETF the cost of trading is small against the amount invested.

Where an index fund comes out ahead

  • SIPs. The amount you choose is invested in full each month, automatically, with no order to place.
  • No trading costs. No brokerage, no spread, no demat charges.
  • Price certainty. You always buy and sell at NAV. An ETF can trade away from its true value, especially a small one or on a volatile day.
  • Always sellable. The fund house redeems your units. A thinly traded ETF may not have a buyer at a fair price when you want one.

How to choose between two funds on the same index

  1. Expense ratio, using the direct plan for an index fund.
  2. Tracking error or tracking difference: how closely it has followed the index.
  3. Size. Larger funds tend to track better.
  4. For an ETF, trading volume. Low volume means a wide spread.

Our list of index funds shows every index fund with its returns, and each fund's page shows its NAV and how its direct and regular plans compare.

The short version

If you invest every month and want it to run by itself, choose the index fund. If you are investing a large amount at once and already trade through a broker, a liquid ETF saves a little. Either is a reasonable core for a portfolio. For how they compare with funds run by a manager, see index fund vs actively managed fund, and for the wider comparison, ETF vs mutual fund.

Questions

Which is better, an ETF or an index fund?

For a monthly SIP, an index fund is usually the better fit: it needs no demat account, buys fractions of a unit and always deals at NAV. For a large one-time investment by someone who already has a trading account, an ETF on a broad, heavily traded index costs slightly less each year. The gap between the two is small either way.

Do ETFs give higher returns than index funds?

They track the same index, so their returns are nearly the same. An ETF's lower expense ratio gives it a small edge on paper, which brokerage, the spread and any gap between its price and NAV can use up. Over long periods the difference is usually a fraction of a percent a year.

What is tracking error?

It is how far a fund's returns stray from the index it follows. Costs, cash held in the fund and the timing of trades all cause it. A lower figure means the fund is doing its one job better. Compare it along with the expense ratio when choosing between two funds on the same index.

Are index funds safe?

An index fund carries the same market risk as the index it tracks. A Nifty 50 index fund will fall when the Nifty 50 falls. What it removes is the risk of a manager picking badly, since it simply holds the index.

Is the expense ratio of an ETF always lower?

Usually, but not always, and the difference from a direct-plan index fund is often small. Check both figures for the specific funds you are comparing.

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