• Ankur Kapur, CFA, CFP

Which ETF or index fund to invest?

Exchange-Traded Funds (ETF) or index funds have emerged as the cheap and best option for a first-time investor. In India, these options are slowly but surely gaining momentum. Find out ways to invest in an equity strategy that is conservative and cheap but yet effective.

Exchange-Traded Funds vs Index Funds

Which mutual fund is best? A lot of first time investors spend time finding an answer to this question. There is an option to gain exposure in equity that no banker or agent would talk. Exchange-traded funds (ETFs) and index funds are simple yet effective ways of investing in the equity market.

A best mutual fund today may turn out to be worst in the future. An exchange-traded fund (ETF) is a collection of securities—such as stocks—that tracks an underlying index say Nifty 50. Whereas, an index fund is a type of mutual fund with a portfolio constructed to match or track the components of a financial market index, such as the Nifty 50 Index. An index mutual fund provides broad market exposure and has low operating expenses.

An ETF requires a demat whereas an index fund does not. You can set up a systematic investment in an index fund but that's not possible in an ETF. Due to these reasons, an index fund is a preferred way to invest.

How to pick an index fund?

Simple, the one that has the lowest expense ratio. Since these are not actively managed, there is no additional research required. An index fund will generate a return similar to the underlying index.

A quick search indicates that the lowest nifty 50 index fund is UTI Nifty index fund with 0.17% expense ratio. As we see more mutual fund companies add index funds, you may find more options that may even be cheaper than this. With time you may find index options in mid-cap and small-cap as well.

If these are good investment options, why do funds or agents don't promote it? The expense ratio of an index fund is 0.15%-0.50% in comparison with a regular mutual fund that has an expense ratio between 1.50% - 2.20%. There is no incentive either for a mutual fund agent or even the mutual fund company.

You should be ideally saving 20% of your income. Out of 20%, invest 5% in an index fund. This recommendation is for first-time investors. As you gain more experience, this percentage, as well as investment product selection, may change.

As your financial complexities increase, you may need to hire a financial advisor but at a basic level, you are better off managing your finances yourself and start investing in an index fund.

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