Mutual Fund Foundations
Chapter 8 of 12
Index funds and ETFs: the passive route
6 min read
An index fund does not try to beat the market. It copies an index such as the Nifty 50, holding the same shares in the same proportions, so its return follows the index's, less a small cost.
Index funds versus ETFs
- An index fund is bought and sold through the fund house at the day's NAV, and works with SIPs.
- An ETF holds the same kind of basket but trades on the stock exchange all day like a share, and needs a demat account.
Why people choose them
- Low cost: there is no research team to pay for, so expense ratios are lower.
- Simplicity: the strategy is known in advance.
- No manager risk: you will not be hurt by a manager's poor call, and you will not benefit from a good one.
Tracking error
No index fund matches its index exactly. The gap, known as tracking error, comes from costs and cash held for redemptions. A good index fund keeps it small.
Key takeaways
- Index funds copy an index at low cost.
- ETFs trade on the exchange; index funds do not.
- Compare tracking error and expense ratio between similar funds.
This content is for education only and is not investment or tax advice. Mutual fund investments are subject to market risks; read all scheme-related documents carefully.