If you are new to investing and wondering where or how much you should be investing, it is better that to first make a financial plan. Financial planning is essential for anyone who seeks wealth creation in the long run. If you are well aware of your short term and long term financial goals, investment planning becomes a lot easier. You are able to chart out an investment strategy and spread your finances across the most apt investment vehicles. Investors should however determine their risk appetite before making an investment decision.
What are index funds?
Index funds might be an ideal investment avenue for those investors who seek capital appreciation through long term investment. An index fund generally invests the exact same proportion as its underlying index, and hence may fluctuate depending on the performance of its underlying index. So if you invest in an index fund who tracks NIFTY 50 as its underlying index, you will have to benchmark NIFTY 50 to track the performance of that index fund.
What are exchange traded funds?
An exchange traded fund (ETF) on the other hand follows a particular index, for example, the S&P 500 Index or NIFTY 50. Exchange traded funds are passively managed funds, which means that these funds do not involve the active participation of the fund manager. Exchanged traded funds are marketable security which can be traded at the exchange just like any other company stock. Unlike actively managed mutual funds, ETFs do not hold net asset value or NAV like mutual funds. Instead, they are measured in units where one unit of an ETF equals one share of the underlying index.
Should you invest in index funds or exchange traded funds?
Now if you want to decide whether you want to invest in index funds or ETFs you should first understand the difference between these two funds.
| Criteria | Index Funds | Exchange Traded Funds |
| Net Asset Value (NAV) | The value of an index fund at the end of the day is deemed as its NAV | The NAV of an index fund keeps fluctuating in real time like the share price of a company stock |
| Portfolio exposure | Investors receive a statement detailing the performance of their index fund at the end of the month | Investors can check the portfolio performance of their ETFs on a daily basis |
| Trading | Investors cannot buy or sell securities, it is the job of the index fund to track its underlying benchmark with minimal tracking error | Exchange traded funds can be bought and sold at the stock market like company stocks |
| Expenses | Investors have to pay a certain expense ratio that covers the recurring costs for managing the fund | Be it buying or selling, ETFs charge for each transaction |
| Holding format | Index funds can be held in digitally without a trading or a demat account | One cannot own exchange traded funds without owning a demat account |
| Fund manager | Index funds do not involve active participation of the fund manager, they are passively managed funds | There are no fund managers involved and investors need to take care of their own investments |
The difference between these two funds can help investors identify if they want to invest in an index or trade with exchange traded funds. If you want to invest and forget and let the fund do the job for you, then you can invest in index funds. But if you are keen on buying and selling and want to trade your funds on a daily basis then you can go with exchange traded funds. Depending on your risk appetite and investment objective you should take the final investment call.
