What’s The Difference Between An ETF And An Index Fund?

One of the hardest parts of stock market investing is choosing where to invest in. With a plethora of options and information from all around the corner, picking stocks becomes difficult. Stock selection is a process that requires strenuous challenges. You want to find a stock that has better growth opportunities and create a portfolio filled with such stocks. But what could make this easier is a way to invest in a fund that has the best stocks in the stock market and each sector.

An option is choosing a fund that tracks an index as it is. Let us learn about indexes and see how you can invest in them.

What are stock market indexes?

Simply put, a stock market index is a list of top stocks in a company. It is a tool used for measuring how the stock market or a particular index is performing. If we take example, if you want to measure how the FMCG sector companies in India are performing, one easy way to do so is by looking at an FMCG index.

Similarly, there are stock market indexes that track the stock market as a whole. These indexes are a good way to gauge how the market is performing in general.  There are two such indexes in India – The nifty and Sensex. These indexes have the top companies in India. Hence, its movements are often indicative of how the stock market is performing in general.

For instance, if the Nifty or Sensex is performing well, the whole stock market’s performance is considered to be going well.

How to invest in a stock market index?

The best way to invest in a stock market index is by investing in a fund that tracks the stock market index you want to invest as it is. Such a fund could decrease the research process and the hardship of maintaining the stock market as well. For this, there are two main options. Index mutual funds and ETFs.

Index fund vs ETFs

Index funds are designed in a way that mimics the performance of a particular index. For this, they keep a portfolio similar to that of an index. Different stocks have different weightage in an index. Index funds try to closely mimic that weightage as well.

These funds are known as active funds. This is because the fund manager doesn’t play an active role in managing the fund. Instead, the portfolio takes care of itself as it just has to mimic the composition of the index. The role of the fund manager is limited to managing the funds whenever there is a change in composition or change in the index. This makes index funds easier to follow.

One important factor to keep in mind here is the tracking error. It is the change in the growth percentage of the fund and the index. This occurs due to multiple factors such as difficulty in holding the same composition as the index changes and expense ratio (fee for managing the fund) collected by the fund houses. Even then, index mutual funds remain a valid option for investors trying to invest in an index as it is.

Another option here is exchange-traded funds or ETFs. They are similar to index funds in most parts but are tradable in the stock market. That means units of ETFs are tradable like stocks. This gives ETFs an advantage when it comes to liquidity. Both ETFs and index funds are similar and beneficial options to invest in an index. Weigh both options after considering your risk appetite and goals before you pin down one.

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