An ETF is also known as an exchange-traded fund. Index funds are open-ended mutual funds schemes. ETFs are funds traded on the stock exchanges. Both the ETF and Index funds are traded on the floor of the stock exchange. There are exchange-traded funds and index funds on different themes like banks, gold, commodities, healthcare, banks, and others. 

Index funds can be made as investments in physical forms or in Demat format. An ETF requires a Demat account to make an investment. It is not possible for SIPs in an ETF whereas in Index funds SIP investments are possible. The Index funds will get their NAV at the end of the day but on an ETF the price will change in real-time with the market’s changing conditions. Index funds have higher expense ratios. 

Both Index funds and ETFs provide enough diversification in the form of tens, hundreds and thousands of securities. These two offer less expense ratio and potential long-term good returns. It can be said that both ETF and Index funds have many things in common. It is difficult to decide which investment product is better for making a passive investment. To better understand these differences here we provide you with the difference between ETF and Index Funds.

  1. Fund Management
  2. Trading style
  3. Minimum investment
  4. Expense Ratio
  5. Liquidity

1. Fund Management

Index funds are passive instruments. ETFs are passively managed or actively managed funds. The investment company is making tactical decisions on building ETF portfolios like which stocks to sell and which stocks to buy and others. 

The ETFs are innovative in their way and successful investors make their investments through these ETFs. Investors such as Warren Buffet have been successful in making investments in ETFs. ETFs focus on disruptive innovation and these include investments in technology firms, innovators, health tech, and other tech companies. Index funds are passive but not all ETFs are passive.

2. Trading Style

Index funds are mutual funds while ETFs come close to stocks and are similar to their operations. ETFs can be traded the same as stocks on the stock market throughout the day. The price of the stocks will increase or decrease in the trading time. The index funds can be purchased or sold at a given price at the end of the trading day. For long-term investments, this is not a concern but if you are looking to time the market then ETF will come as handy with features like intra-day trade, stop loss, order limits, and others. 

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3. Minimum Investments

As a practice, the ETFs are bought in units and just like you buy stocks of a company like 10 or 20 stocks of a company you have to purchase 1 unit, 8 units, 100 units, and others. If you are investing in one unit of an ETF then you are making an investment in the form of multiples of that one unit. 

Index funds are purchased and traded in the form of an amount. If you invest in a certain amount then you are trading on an amount. You can invest in Index funds in AED 500 or AED 1000 or AED 2000 in an index fund. 

The unit versus amount has a bearing on the minimum investment that one puts in while purchasing either of these financial products. Most of the trading platforms will allow investors to purchase one unit. When you are buying some units in index funds all mutual fund companies require a minimum order of a certain amount. 

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4. Expense ratio

Both the Exchange-traded funds and index funds have low expense ratio. It means that the fee is raised for mutual funds for managing money in that ratio. When we are comparing ETFs and Index funds you will realize that ETFs are cheaper than Index funds in many aspects. 

The expense ratio for index funds is a direct variant. There are two different additional costs that investors should be aware of. The additional expenses are fees collected by the broker or the trading platform. This is in the form of a percentage or a fee that is directly related to the transaction.  

5. Liquidity

When the investor makes the investment in the index fund the mutual fund company will add funds to the Asset under management. In line with the benchmark, it will go about buying the securities. There is no concern about liquidity when you are redeeming in effect with index funds. 

Under an ETF the lack of liquidity can be a concern because buying an ETF is like buying any other equity share. Where you want to sell 100 units of ETF and there are no buyers for the units. In this situation, there exists a problem of not finding buyers which will create a problem of liquidity with ETFs. 

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Vinay Kumar Goguru is a finance professional with more than 8 years of diverse experience as a researcher, instructor and Industry work experience with both public and private entities. Prior to MyMoneySouq, he spent 6 years in Berkadia, It's a commercial mortgage banking company. He has a "Doctoral Degree in Commerce" and two master's degrees with a specialization in Finance, one as Master of Commerce and other as Master of Business Administration. He has written several articles on personal finance, published by different International journals. He loves traveling, reading and writing is his passion. He has a dream of writing a book on his favorite finance topics.

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