ETF vs Index Fund: Key Differences You Must Know

The trend of passive investing is growing rapidly in India, where people are investing in funds that follow indexes like Nifty 50 or Sensex. The AUM of passive funds in India is expected to reach ₹11.13 lakh crore in 2025, which includes both ETFs and index funds.

Both these options provide low-cost investment, but there are some important differences between them. In this blog, we will understand the difference between Index Funds and ETFs in simple language and know which one is better for you.

What is an Index Fund?

An index fund is a type of mutual fund that tracks a certain market index (such as Nifty 50 or Sensex). Its objective is to replicate the performance of that index. This fund invests in shares of only those companies that are part of that index, and investment is made in the same proportion as that of index.

• Passive Investment Strategy : In an index fund, stocks are not selected by an active fund manager. Instead, investment is only made in shares that are index constituents. This is why it is called a passive investment strategy. Its expense ratio is also low due to less analysis required.
• Transaction Process : Index funds are bought and sold at the NAV (Net Asset Value) declared at the end of the day. That is, there is no continuous buying and selling during the day, as is the case with ETFs.
• Not Expensive : It is possible to invest small amounts at regular intervals in this fund through SIP (Systematic Investment Plan) and build your investment portfolio over time. 

Key features in brief:

• Invests in index-based stocks
• Not actively managed
• Low cost and low risk
• SIP facility available

Read Also:What is Nifty BeES ETF? Features, Benefits & How to Invest?

What is an Exchange-traded fund?

An ETF, i.e., an exchange-traded fund, is a fund that tracks a particular stock market index, such as the Nifty 50 or Sensex, gold, silver, etc. The main difference between an index fund and an ETF is that it can be bought and sold in real time in the stock market, like shares of a company.

• Intraday trading facility : ETF is traded on the stock exchange, so its price keeps changing throughout the day depending on demand and supply. Investors can do intraday trading in it; that is, buying and selling is possible on the same day.
• Investment process and requirements: Demat and trading accounts are mandatory for investing in an ETF because its units trade like stocks. This fund is suitable for those who want to manage their investments a little more actively.
• Low cost and transparency : The expense ratio of ETFs is very low, and they follow the index in a transparent manner due to low tracking error. Apart from this, ETFs also have high liquidity, as they can be sold anytime during market hours.

Key features in brief:

• Can be bought and sold in real-time in the stock market
• Tracks a specific index, gold, silver, etc.
• Demat and trading account mandatory
• Low expense ratio
• Facility for intraday trading

Read Also: How to Invest in ETFs in India – A Beginner’s Guide

Difference Between ETF and Index Fund

The table below presents the key differences between ETFs and index funds. The comparison is based on important aspects such as investing method, cost, tax, investment process, and liquidity. This table is useful for both professional investors and beginners to make the right decision.

Parameter	ETF (Exchange Traded Fund)	Index Fund
Investment Process	Trades on stock exchanges like individual stocks.	Bought or sold only at the end-of-day NAV.
Liquidity	High liquidity – can be bought/sold any time during market hours.	Relatively Lower liquidity – transactions occur only once a day based on NAV.
Expense Ratio	Exchange-traded funds have a lower expense ratio than index funds.	Index Funds have a higher expense ratio than exchange-traded funds.
SIP Availability	SIP cannot be done.	SIP can be done.
Demat Account Requirement	Mandatory requirement of both demat and trading accounts for investing.	Not required, if you prefer to hold the mutual fund units in physical form.
Minimum Investment	Can start with the price of one unit	Minimum SIP amount usually starts at ₹500 or ₹1000.
Pricing Mechanism	Real-time market price fluctuates based on demand and supply throughout the day.	NAV-based pricing calculated and declared once daily.
Investment Experience	Requires technical understanding of trading, pricing, and brokerage.	Simple and user-friendly; ideal for beginners.

Both ETFs and index funds are great options for passive investment. ETFs offer more flexibility, liquidity and trading experience but require a Demat account. On the other hand, index funds are simple, safe, and ideal for long-term investing with features like SIP.

Pros and Cons of Index Funds and ETFs

Pros and Cons of Index Funds

Pros :

• It is easy to start investing as a Demat account is not required for investing in Index funds mutual funds.
• It is possible to make regular and systematic investments through SIP.
• The most suitable and simple option for new investors.

Cons :

• There is no real-time trading; transactions are done only at the end of the day on NAV.
• Tax efficiency is less than ETFs.
• There is not much flexibility in trading.

Pros and Cons of ETFs

Pros :

• Can be traded on the stock exchange during market hours.
• The expense ratio is low, which reduces the cost.
• Transparency and liquidity are high.

Cons :

• Demat and trading accounts are required for investing in ETFs.
• SIP facility is not generally available, so regular investment can be a bit difficult as investors have to invest manually.
• There may be additional expenses incurred during trading, such as brokerage and bid-ask spread.

Both options have their own advantages and disadvantages, so the choice of investment depends on the individual’s needs and investment style.

Which Should You Choose?

Deciding between index funds and ETFs can be tough. You can refer to the points mentioned below to make a smart investment decision: 

• Investment goals and period : If you want to make stable and regular investments for a long period, then an index fund is better. It has the facility of SIP, through which small investments can be made at regular intervals without much effort. It is also an easy and suitable option for new investors.
• Active vs Passive Investment : If the risk-taking capacity is high and you want to take advantage of the ups and downs of the market, then an ETF is a better option as the investor can actively trade it on the stock market. On the other hand, if the investor prefers a passive investment, then an index fund should be the priority.
• Investment platform and requirements: Demat and trading accounts are mandatory for investing in an ETF, along with market understanding. In contrast, an index fund can be purchased directly from the fund house, in which a Demat account is not required.

One should choose between an ETF or index fund keeping in mind the investment goal, risk capacity, and available resources. The right choice ensures maximum profit and security of investment.

Know More: Calculate returns on ETF investments.

Conclusion 

Both ETFs and index funds are great and low-cost options for passive investing. The main difference between the two is in the trading process, liquidity, tax efficiency, and investment method. ETFs can be traded on stock exchange and are more transparent, while index funds are simpler to invest in and suitable for SIPs. To make the right choice, it is important to evaluate your investment goals, risk tolerance, and available resources. It may also be wise to consult a financial advisor before starting to invest.

Frequently Asked Questions (FAQs)