Index fund vs ETF
Same index, often the same portfolio; the difference is how you buy and sell.
An index fund and an exchange traded fund (ETF) can track the very same index with the very same portfolio. The difference is how you buy and sell: an index fund is bought from and sold back to the fund house at the day's NAV, while an ETF is bought and sold on a stock exchange at the market price, through a broker and a demat account.
SEBI puts both in one category, 'Index Funds/ETFs', and requires each to keep at least 95% of total assets in the securities of the index it tracks. So the 'which is better' question is mostly about access, liquidity and cost, not about what you own.
Index fund vs ETF at a glance
Where you transact
Index fund
With the AMC, directly or through a distributor
ETF
On a stock exchange, through a broker
Price you get
Index fund
End-of-day NAV, by the cut-off time rules
ETF
Live market price during trading hours
Demat account
Index fund
Not needed
ETF
Needed
SIP
Index fund
Available as a normal mutual fund SIP
ETF
Depends on the broker; there is no AMC SIP in the ETF itself
Liquidity
Index fund
The AMC redeems units
ETF
Depends on buyers and sellers on the exchange, supported by market makers
Extra costs
Index fund
Exit load if the scheme has one
ETF
Brokerage and the bid-ask spread
Price vs NAV
Index fund
Always at NAV
ETF
Can trade at a premium or discount to NAV
| Point | Index fund | ETF |
|---|---|---|
| Where you transact | With the AMC, directly or through a distributor | On a stock exchange, through a broker |
| Price you get | End-of-day NAV, by the cut-off time rules | Live market price during trading hours |
| Demat account | Not needed | Needed |
| SIP | Available as a normal mutual fund SIP | Depends on the broker; there is no AMC SIP in the ETF itself |
| Liquidity | The AMC redeems units | Depends on buyers and sellers on the exchange, supported by market makers |
| Extra costs | Exit load if the scheme has one | Brokerage and the bid-ask spread |
| Price vs NAV | Always at NAV | Can trade at a premium or discount to NAV |
Terms that decide the answer
- Tracking error
- The annualised standard deviation of the difference in daily returns between the index and the fund's NAV. SEBI caps it at 2% for ETFs and index funds other than debt ones, measured on one year's rolling data, and requires daily disclosure.
- Tracking difference
- The annualised difference in returns between the index and the NAV, disclosed monthly for 1, 3, 5 and 10 years and since launch. It shows the real drag of costs.
- iNAV
- Indicative NAV of an ETF during trading hours. For equity ETFs it must be updated on the exchange within 15 seconds of the underlying market, so you can see if the price is far from value.
- Market maker
- An exchange member appointed by the AMC to keep quoting buy and sell prices for an ETF. SEBI requires at least two for every ETF.
SEBI rules that apply to the ETF route only
- check_circleOrdinary investors buy and sell ETF units on the exchange. Dealing directly with the AMC is allowed only for orders above ₹25 crore, a threshold that does not apply to market makers.
- check_circleIf an ETF trades at a discount of more than 1% to NAV for 7 continuous trading days, has no quotes for 3 consecutive trading days, or has thin bids, investors may redeem directly with the AMC up to ₹25 crore without exit load.
- check_circleWhen the index changes its constituents, both ETFs and index funds must rebalance within 7 calendar days.
Free account, this exam preselected.
Same index, same tax
Tax follows the portfolio, not the wrapper. An index fund and an ETF that both hold at least 65% in listed Indian equity are both equity-oriented funds, taxed at 20% on short-term gains and 12.5% above ₹1.25 lakh on long-term gains. The mutual fund taxation page covers the other cases.
How V-A tests this
Questions describe an investor and ask which product fits. No demat account and wants a monthly SIP: index fund. Wants to buy and sell during market hours at a known price: ETF. The trap option says an ETF is bought from the AMC at NAV; that is true only for market makers and very large orders.
Statement questions test the tracking measures: tracking error is a standard deviation, tracking difference is a return gap. Candidates swap the two, or think a passive fund promises to match the index exactly.
FAQs
Should I buy an ETF or an index fund?expand_more
It depends on how you invest, not on returns alone. ETFs need a demat and trading account and trade at market prices; index funds are bought at NAV from the fund house and suit SIPs. Compare tracking difference and total cost for the specific schemes you are considering.
Is an ETF cheaper than an index fund?expand_more
Not necessarily. Compare expense ratios scheme by scheme, and remember that an ETF investor also pays brokerage and the bid-ask spread, and may buy at a premium to NAV. The total cost is what matters.
Can I do a SIP in an ETF?expand_more
Not through the AMC in the usual way, because ETF units are bought on the exchange. Some brokers offer a periodic purchase facility. An index fund takes a normal SIP.
What is tracking error in an index fund?expand_more
The annualised standard deviation of the difference between the fund's daily returns and the index's daily returns. SEBI caps it at 2% for non-debt index funds and ETFs.
Access exam-specific mock tests directly from your Android device.Trusted by learners and rated 4.6★ on Google Play.