The growth of mutual funds as a viable investment choice for regular investors has made them one of the most sensible ways to invest money. Investing in mutual funds is convenient, and there are numerous schemes to select from.
Across different mutual fund schemes, the investment portfolio may be handled actively or passively. While active investing requires fund managers to make active investment decisions, passive investing tracks benchmark indices rather than fund managers making autonomous investment decisions.
Because benchmark indices are widely discussed and understood, passive investing may make the investing process relatively simple for investors. Passive investment products may be more accessible for investors to grasp as an investment alternative. Even in risk management, passive investment products seek to reduce investors' overall investment risk.
Investing hazards are usually defined as systematic or unsystematic. While systematic risk refers to unfavourable market events adversely impacting the investment portfolio, the unsystematic risk may be specific to a single sector or company.
Investors who choose passive investment alternatives rely on broader market expertise rather than fund managers' investing ideas. This enables them to reduce unsystematic risk from financial strategies, reducing overall investment risk.
Within passive investing, index funds and Exchange Traded Funds (ETFs) are two investment choices. These funds replicate underlying indices to monitor specific market niches, like the nifty 50 index fund and the Nifty 50 ETF. While each of these goods appears identical, there are some differences between them.
The distinctions between Index Funds and ETFs are described further below.
Investing Mode
In terms of investment, index funds like the nifty 50 index fund are no different than any other mutual fund plan. As a result, investors can invest in an index fund by submitting an application form in person or online at the mutual fund house's website. In addition, people can invest in index funds through a Demat account or an investor folio.
Individuals can also invest through an asset management firm's website or mobile application. On the other hand, ETFs like the Nifty 50 ETF can be purchased through stock exchanges or directly from the AMC in a specific lot size. Furthermore, investors can only hold ETF units in a Demat account.
Transaction fees
As passive investment solutions, index funds and ETFs have lower expense ratios than managed mutual fund schemes due to reduced fund management fees. Index funds, conversely, do not imply any additional transaction fees aside from scheme expenditures, whether at the time of investment or redemption from such schemes.
In contrast, investing in or redeeming ETF units through stock exchanges may incur expenses because such orders incur specific transaction costs such as brokerage, taxes, exchange charges, etc. Such transaction charges are paid on both sides of the transaction, i.e. on the buy and sell sides.
Transaction price
Index funds like the nifty 50 index fund are only available to investors through mutual funds. Mutual fund transactions occur at the fund house's daily Net Asset Value (NAV).
In contrast, ETF funds can be traded on stock exchanges, with transactions occurring at real-time prices rather than the daily NAV. As a result, the transaction price may differ from the current market value because the demand and supply of ETF Units determine the cost of ETF units on the stock exchange.
The greater the discrepancy between demand and supply, the greater the difference between the transaction price and the current market price, i.e., the impact cost. Such impact costs have a direct influence on investor returns and are hence sought to be kept low.
Liquidity
When it comes to investing in or redeeming index funds like the nifty 50 index fund, liquidity is not a concern. This is because index fund transactions are carried out through mutual fund firms at the current NAV. On the other hand, liquidity for ETF units on stock exchanges may be reduced depending on the demand and supply of such units.
If there are no or fewer buyers for an ETF fund, an investor who wishes to sell their ETF assets may be unable to do so or may be able to do so at a reduced transaction price.
While AMCs hire market makers to provide ETFs with additional liquidity by providing two-way quotes on stock exchanges at all times, investors may incur impact costs when trading in ETFs.
Hence, while both index funds and ETFs enable investors to attain the goal of passive investing, investors may pick between index funds and ETFs based on the above differences.
Disclaimer: Mutual Funds are subject to market risks. Please read all scheme-related documents carefully before investing.
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