Passive investing has gained significant traction among Indian investors, largely because of low costs. Exchange Traded Funds (ETFs) and index funds constitute the two main passive investment vehicles. Both replicate the performance of benchmark indices. Since these funds replicate the same companies and weightings as the indices they follow, they require little active management resulting in lower expense ratios.
While both options perform similarly and share core principles, it is important for new investors to understand the structural differences between them. The following points highlight these distinctions.
NAV vs Price
A key difference between ETFs and index funds is how they are traded. ETFs, like stocks, are bought and sold on exchanges throughout market hours with real-time price changes, allowing investors to trade based on their current market prices. Index funds function like traditional open-end mutual funds, with a Net Asset Value (NAV) calculated once daily, and trades executed at that fixed price.
ETFs can trade at premiums or discounts to their NAV due to supply and demand. For example, six global index-tracking ETFs have traded above their NAVs in recent periods because of high demand and limited market makers who typically help align prices. These premiums can reduce returns when prices converge with NAV. Index funds avoid this issue, offering units at the calculated NAV without intraday price swings.
Liquidity
Liquidity or trading volume are crucial factors for ETFs. Since they trade on stock exchanges, active buyers and sellers are needed for fair pricing. ETFs tracking major indices — like the Nifty BeES ETF with a ₹214-crore average daily turnover last month — typically have strong liquidity and smooth trading.
But niche or thematic ETFs often have low trading volumes, leading to wider bid-ask spreads and price deviations from NAV. For instance, the Nippon India ETF Dividend Opportunities averaged just ₹60 lakh in daily volume. In contrast, index funds, while not offering immediate liquidity during market hours, ensure execution at the fair NAV.
Expense ratio
One major advantage of both ETFs and index funds is their low expense ratios. If the underlying portfolio is the same, a fund with a lower expense ratio will deliver higher returns compared to the one with a higher expense ratio. ETFs are especially known for low costs—for example, equity ETFs like ICICI Pru BSE Sensex ETF have expenses as low as 0.02 per cent. However, commodity, thematic and global ETFs can be more expensive, with some like Nippon India ETF Nifty Infrastructure BeES charging up to 1.03 per cent.
Index funds from large fund houses have reached a scale that allows them to match or undercut ETFs when total costs are considered. As of March 2025, regular plans had expense ratios from 0.29 per cent to 1.09 per cent, while direct plans ranged from 0.05 per cent to 1 per cent, with Edelweiss Nifty 50 Index Fund offering the lowest at 0.05 per cent.
Total cost of ownership
When evaluating ETFs, investors should consider the total cost of ownership (TCO), not just the expense ratio. TCO includes the expense ratio plus costs such as brokerage, bid-ask spreads and NSDL charges. For instance, a note from DSP Mutual Fund shows that an ETF with a 0.05 per cent expense ratio can have a TCO of 0.42 per cent after adding transaction costs. While these may seem small, they can add up for frequent or small, regular investments.
Index funds typically avoid such transaction-specific costs, as these are built into their expense ratios. Interestingly, direct plans of many index funds score over their ETF counterparts.
Variety advantage
Both ETFs and index funds are now offered by fund houses across a range of asset classes—including equity, debt, gold, silver and global markets. Based on ACEMF data, there are currently 264 ETF schemes compared with 206 index fund schemes. ETFs tend to offer greater variety, especially in thematic and smart beta segments. For instance, liquid ETF and ETFs track specific themes and sectors such as metals, New Age Consumption, and Oil & Gas, which are not currently available in index funds’ landscape.
Account essentials
Investing in ETFs requires a demat and trading account, and these come with additional maintenance charges. Index fund investments, on the other hand, do not require either account, making them easier for beginners. For investors interested in ETFs but lacking a demat account, fund of funds (FoFs) offer an indirect way to invest in ETFs. However, FoFs bring their own costs—incurring charges for both the FoF and the underlying ETF.
SIP facility
Systematic Investment Plans (SIPs), which allow for regular fixed investments, are widely available for index funds. ETFs generally do not offer SIPs directly due to their stock-like trading nature. However, some brokers have created SIP-like features that allow for recurring ETF purchases through trading platforms. Additionally, FoFs make SIPs possible for ETFs indirectly.
Minimum investment
Investing in ETFs requires purchasing at least one unit at the current market price, which can be as low as ₹10. For instance, a unit of the Mirae Asset Nifty Metal ETF is currently priced around ₹8.5. Index funds often have minimum investment requirements, sometimes starting at just ₹100.
Suitability
Index funds serve as a great entry point for first-time investors or those who prefer a simplified investment method. Their lower barriers to entry, lack of transaction fees and compatibility with systematic investing make them particularly appealing for long-term, disciplined investors. ETFs, with their flexibility for intraday trading, are better suited for seasoned investors, institutional players and those who employ tactical and active portfolio strategies.
Published on May 3, 2025
