Index Fund vs. ETF vs. Mutual Funds: What's the Difference?

Index funds and exchange-traded funds (ETFs) are low funds compared to mutual funds, with lower expense ratios. In this article, you will know about the detailed comparison between Index fund, ETFs, and Mutual funds.

Along with this, the past and future trends of mutual funds, index funds, and ETFs will also be known within India and also with the USA.

Types of Mutual Funds

We all know mutual funds that if one does not want to invest directly inside the stock, then he can do it through mutual funds. Where we get diversification and our risk is reduced a bit. And a fund manager that we get expertise, but even here mutual funds also become of two types

Active Mutual Funds
Passive Mutual Funds

What are Active Mutual Funds

In an Active Mutual Fund, the fund manager keeps tracking the company regularly, keeping an eye on which company is doing well in today’s time, sometimes buying stocks, sometimes selling stocks. The main aim of an active mutual fund is to beat whatever benchmark or index it is comparing to.

For example, if someone is comparing Nifty 50, then suppose Nifty 50 has increased on an average 15% in any one year, then the target of a mutual fund is to give more than 15% return.

But apart from this, there are also other types of funds which are called passive mutual funds.

What are Passive Mutual Funds

Passive mutual funds are those funds where they follow the index, their goal is not at all to beat the index, but their goal is to follow the index only. Passive Mutual Funds will not give you the same return.

An index like the Nifty index, if a fund replicates a similar index, then we call it index fund. For example, stocks that are within nifty 50 will buy stocks in index funds in the same weightage as they are in the index fund.

Similarly, stock buying strategy remains in the same manner inside ETFs, so inside index funds and ETFs are very similar here.

Not only Nifty 50 but there can also be other types of indices like Bank Nifty, IT index, FMCG index, Nifty next 50, etc. So in this way, anyone fund can track different indexes.

But the question comes here that if this passive fund cannot beat ETF and index funds then why should we invest in an index.

Mostly you will see that most of the big company funds that track funds are not able to beat them as the data suggests.

So that’s why many people think that if any fund is not able to beat the index then why do we have to pay more management fees. Because mutual funds charge 1 to 2% management fee.

So if they are not able to justify that fee, then we should invest in a passive fund where the expense ratio (fees) is very less.

Difference Between Index Funds and ETFs

What are Index Funds

The index fund is a type of mutual fund only, the fund collects money from investors and that money is being managed by the fund manager, investing in different types of stocks and those stocks are following an index.

But the main difference is the expense ratio in index funds and mutual funds, here on average expense ratio ranges from 0.1% to 0.3%, almost 1/10 of the cost becomes a big difference.

What are ETFs (Exchange-traded funds)

ETFs operate slightly differently than mutual funds, like tracking an index fund within an index fund. Similar ETFs also follow an index and will buy stocks in the same manner as those bought within the index.

If the ETF follows the Nifty 50, then it will buy the stocks of Nifty50 in the same weightage. But whenever a new fund comes in ETF, at the same time invest within the new fund offer (NFO).

In ETFs, the fund cannot increase frequently like a mutual fund or index fund, for example, it started with 500 crores but the asset under management can be 5000 and 10,000 crores as it grows.

But if ETF is launched then money comes to it as it comes to a company in IPO similarly once the money comes to the fund then its asset under management is closed, and that money is going to remain the same.

So this is an ETF, it has got a value and its shares are distributed among all the investors, and those shares are traded through your Demat account. You invest in them as stocks are traded similarly, ETFs are also traded.

Types of ETFs

There are three types of ETFs:

Equity ETF (invested inside Stocks)
Debt ETF (invested inside Bonds)
Gold ETF (Invested in Physical Gold)

ETFs become the most popular product after mutual funds if seen, index fund is not so popular right now.

Cost of ETFs: The reason for this is also because the cost of ETFs becomes less than that of index funds. In ETFs, the expense ratio starts from 0.01%.

Difference Between Mutual Funds, Index Funds and ETFs

Trading & Pricing

Mutual Funds: if we invest in mutual funds and index funds, then we are assigned a unit called NAV (Net Asset Value). As its value keeps on increasing, then that is your growth (return).

ETFs: But if we talk about ETFs, then as we talked about here once the money comes to the fund, after that its shares are distributed to the shareholders (investors). Their price is real-time, the price of the stock in the market is real-time. similarly, ETFs are also traded in the market.

So the price discovery here is very instant, here you do not have to wait like NAV in mutual funds and index funds will be at the end of the day, you will invest in that.

In ETFs, you can invest in real-time whatever price is there, which means its trading is also intraday, people do intraday trading in stocks, they also do it inside ETFs.

2. Management

Mutual Funds: There is active management inside the mutual fund, no index is being followed here. The fund manager will buy and sell whatever stock he wants.

Index Funds: There is passive investing inside an index fund and following an index.

ETFs: There is also passive investing in ETFs.

3. Expense Ratio

Mutual funds: Mutual funds have a slightly higher expense ratio (1% to 2%).

Index funds: Index funds have medium expense ratios (0.1% to 0.3%).

ETFs: Especially inside ETFs, when we are talking about equity ETFs, here the expense ratio becomes even lower, the lowest is the expense ratio. The expense ratio starts from 0.01%.

The first highlight of ETFs is that their expense ratio is quite low and the second is their real-time trading.

4. Demat Account

Mutual Funds: Demat account is not required inside the mutual fund.

Index Fund: Demat account is not needed inside the index fund.

ETFs: Demat account is required inside ETFs, just like for buying stocks, here also you need a Demat account.

When we are trading inside the Demat account, some brokerage or charges may be levied.

Discount brokers do not charge your brokerage like we take delivery of any stock. There is no brokerage charge, but when we sell a stock or sell an ETF, DP charges are applied at that time. But it is not much.

5. Liquidity

Mutual Funds: Liquidity in mutual funds is very high as there are many mutual funds in India. You are putting money with a fund, you can withdraw whenever you want to withdraw cash. The mutual fund will sell some stocks and give you money.

Index Fund: Index funds are also operating like mutual funds, so liquidity is high here.

ETFs: Liquidity inside ETFs is low as of today, many people are not trading in ETFs right now. But it has gradually improved, if we talk about the last four-five years, now a lot of trading has started inside ETFs.

The market reality of ETFs has increased significantly if we talk about the USA.

6. Effort Needed

Mutual Funds: There are negligible efforts inside Mutual Funds.

Index funds: There is a negligible effort within the Index fund as well.

ETFs: You have to put a little effort inside ETFs because the pricing should be well understood that at what price to buy it in the end. Like we talk about stock though not as difficult as stock.

If we talk about mutual funds, the data says that wherever they are investing in mutual funds inside large-cap companies, they are not able to compete with the index.

But within small-caps and midcaps, a fund manager gets a huge area and a lot of options are available to invest. So here it can compete with the index, such data suggest.

Past and Future Trends of Mutual Funds, Index Funds and ETFs

Compare market data to see how past and future trends have been in Mutual Funds, Index Funds, and ETFs in the USA and India.

USA

By 1995, ETFs and index funds were rarely popular, only 3%. The total AUM of their asset under management as compared to the mutual fund industry increased to 14% in 2005. 41% in 2020, almost half of people are doing passive investing and half are investing in active mutual funds.

India

India’s market is just a little behind the USA, but even here the trend is almost the same. If we talk about passive funds here, then in 2016 the asset under management was only 1.40% of the total industry including index fund of about 22 thousand crores and ETFs.

And in June 2021, the asset under management inside the ETF is more than 3 lakh crores, there is not much investment in the index fund but in 2021 it has become 9.6% in total.

From 1.40% today to 9.65% and in the coming 5 years also it is being indicated that this trend will continue and it will increase to 33.33%.

People are now preferring to invest in ETFs and indices. ETFs are a very good product but the problem is still the same that the liquidity inside it is a little less, though not as low as it was 5 years ago.

This article is only for education purpose and the author has his own views and research, so if you invest in these stocks then do it at your own risk and do the research yourself before investing.

FAQ

What is the trend of Mutual Funds, Index Funds, and ETFs in India?

India’s market is just a little behind the USA. In2016 the asset under management was only 1.40% of the total industry including an index fund of about 22 thousand crores and ETFs. And in June 2021, the asset under management inside the ETF is more than 3 lakh crores, there is not much investment in the index fund but in 2021 it has become 9.6% in total.