ETF vs Index Fund: Which Passive Fund is Right for You? (2025 Guide)

This article covers the critical differences between Exchange Traded Funds (ETFs) and Index Funds for Indian investors in FY 2025-26. We analyze the structural distinctions, cost implications (expense ratios from 0.02%), and suitability for different investor profiles. The analysis reveals that while ETFs offer lower costs and intraday liquidity, Index Funds remain superior for systematic investing (SIPs) due to operational simplicity. With passive assets under management (AUM) crossing ₹13.31 Lakh Crore as of October 2025, understanding this choice is vital for your portfolio.

In the rapidly evolving Indian financial landscape, the debate between ETF vs Index Fund has moved beyond just costs. It is now about execution efficiency, tax planning, and alignment with your financial goals. Both instruments track the same underlying benchmarks—like the Nifty 50 or Sensex—yet they serve very different types of investors. Whether you are a salaried professional looking to automate wealth creation or a trader seeking real-time market exposure, making the right choice can significantly impact your long-term returns. Let’s break down the mechanics, math, and market realities of these two passive giants.

ETF versus Index Funds

To make an informed decision, you first need to understand the structural differences. While the underlying asset (the index) is identical, the vehicle you use to access it changes the user experience entirely. The table below compares these two options based on current market specifications for November 2025.

Data Source: NSE specifications and AMC disclosures as of November 2025. Tax rates as per Union Budget 2024-25.

What are Exchange Traded Funds?

Exchange Traded Funds (ETFs) are essentially mutual funds that trade like stocks. Imagine a basket of securities that mirrors an index, but instead of buying units from a fund manager at the end of the day, you buy them from another investor on the stock exchange in real-time.

How ETFs Work

ETFs are listed on exchanges like the NSE and BSE. Their price fluctuates second-by-second based on demand and supply, though it stays tethered to the underlying index value (NAV) through a mechanism involving Authorized Participants (APs).

Key Characteristics:

• Real-Time Pricing: You can buy at 10:00 AM and sell at 2:00 PM. This allows you to capitalize on intraday market movements.
• Creation/Redemption: Large investors (APs) create or redeem units directly with the AMC in large blocks, keeping the market price close to the NAV.
• Settlement: As of November 2025, ETFs follow the T+1 settlement cycle. (Note: An optional T+0 beta version exists for select counters, but T+1 remains the standard for most retail transactions).

Popular Examples in India:

• Nippon India ETF Nifty BeES: One of the most liquid ETFs tracking the Nifty 50.
• SBI Nifty 50 ETF: A massive fund often used by provident funds.
• HDFC Nifty 50 ETF: Known for competitive expense ratios.

What are Index Funds?

Index Funds are classic mutual funds that passively replicate an index. Unlike ETFs, they do not trade on an exchange. You deal directly with the Asset Management Company (AMC) or through a distributor.

How Index Funds Work

When you invest in an Index Fund, your money is pooled with other investors to buy the exact stocks in the index, in the exact same proportion.

Key Characteristics:

• End-of-Day Pricing: Regardless of market volatility during the day, your purchase or redemption happens at the closing NAV.
• No Demat Required: You can hold these units in a Statement of Account (SOA) format, though Demat is optional.
• Guaranteed Liquidity: The AMC is legally obligated to redeem your units at the applicable NAV, eliminating the risk of finding a buyer in the market.

Popular Examples in India:

• UTI Nifty 50 Index Fund: One of the oldest and largest in the category.
• Bandhan Nifty 50 Index Fund: Known for cost-efficiency.
• Navi Nifty 50 Index Fund: Often cites very low expense ratios in the direct plan category.

Benefits of Passive Funds – ETFs and Index Funds

Both vehicles have driven the massive surge in passive investing, with the segment commanding approximately 17% of total mutual fund AUM in India (₹13.31 Lakh Crore as of October 2025). Here is why they are winning over smart investors.

Low Cost of Investment

Cost is the biggest predictor of long-term returns. Active funds typically charge 1.0% to 2.0%. In contrast, passive funds are a bargain.

• ETFs: Expense ratios can be as low as 0.02% to 0.05%. For example, the ICICI Prudential Nifty 50 ETF charges around 0.02%.
• Index Funds: Direct plans typically range from 0.10% to 0.30%.
• Impact: On a ₹50 Lakh portfolio over 20 years, a 1% difference in fees can effectively eat up over ₹25 Lakh in potential compounding (assuming 12% returns).

Diversification

With a single purchase, you own a slice of the entire market.

• Nifty 50: Exposure to the top 50 companies.
• Nifty Next 50: Exposure to the next 50 emerging blue-chips.
  This eliminates “unsystematic risk”—the risk that a single company (like Satyam or DHFL in the past) destroys your portfolio.

Transparency

You always know exactly what you own. Unlike active funds where a manager might take a tactical cash call or buy an unknown small-cap, passive funds mirror the index. If Reliance Industries is 9% of the Nifty 50, it is 9% of your portfolio.

Tax Efficiency

Passive funds generally have lower portfolio turnover than active funds, which reduces transaction costs within the fund. For you, the tax rules are straightforward (for equity-oriented funds >65% equity):

• LTCG (Held > 12 months): 12.5% on gains exceeding ₹1.25 Lakh per financial year (As per Union Budget 2024-25).
• STCG (Held < 12 months): 20% flat on gains.

Consistent Performance

Data consistently shows that over 10-15 year periods, 60-80% of active large-cap funds fail to beat the benchmark (Nifty 50 or Nifty 100). By choosing an ETF or Index Fund, you guarantee yourself market returns, ensuring you don’t underperform the economy.

Where Should You Invest – ETFs versus Index Funds?

The “best” option depends entirely on your investment mode and psychology. Here is the breakdown.

Choose ETFs If:

1. You Have a Lump Sum: If you are deploying ₹5 Lakh or ₹10 Lakh at once, the lower expense ratio of an ETF (0.05% vs 0.20%) makes a tangible difference.
2. You Are a Trader: If you want to buy the dip at 11:30 AM when the market crashes 2% and sell the bounce at 3:00 PM, only an ETF allows this.
3. You Have a Demat Account: If you are already active on platforms like PL Capital, buying an ETF is as seamless as buying a stock.

Choose Index Funds If:

1. You Are an SIP Investor: This is the most critical factor. While brokers offer “Stock SIPs” for ETFs, they are clumsy—they place market orders at a specific time. Index Funds offer true SIPs where money is deducted, and fractional units are allotted.
2. You Want Simplicity: No need to worry about bid-ask spreads, liquidity, or market depth. You send money; you get NAV.
3. You Dislike Tracking Error: In volatile markets, ETF prices can drift from their NAV (premium/discount). Index funds execute exactly at NAV.

Verdict for Most Indians:
For wealth creation via monthly savings (SIP), Index Funds are superior due to automation and fractional unit allotment. For tactical deployment of large cash piles, ETFs win on cost.

Conclusion

Both ETFs and Index Funds are powerful tools for wealth creation, democratizing access to India’s growth story. The choice between ETF vs Index Fund ultimately boils down to convenience versus cost. If you are a disciplined SIP investor, the Index Fund is your best friend. If you are a tactical investor with lump sum capital, the ETF offers precision and savings. The most important step is not splitting hairs over 0.05% fees, but starting your investment journey today.

Ready to build your passive portfolio? Open your PL Capital account and start investing in top-rated ETFs and Index Funds today.

FAQs on ETF vs Index Fund

1. Which is Better, ETF or Index Fund?

Neither is universally better; it depends on your style. Index Funds are better for monthly SIPs and hands-off investors due to automation and no Demat requirement. ETFs are better for lump-sum investments and active traders who want lower expense ratios (0.05%) and intraday execution.

2. Can I Do SIP with ETF?

Yes, but it is not a “true” SIP. Brokers offer a “Stock SIP” feature that places a buy order for ETF units at a specific time monthly. Unlike Index Funds, you cannot buy fractional units, so your investment amount may vary slightly each month based on the ETF price.

3. Is the S&P 500 ETF an Index Fund?

Yes, technically. An S&P 500 ETF is an index fund that trades on an exchange. In India, you can invest in the S&P 500 via ETFs (like Mirae Asset S&P 500 Top 50 ETF) or Fund of Funds (like Motilal Oswal S&P 500 Index Fund). Note that international taxation rules apply.

4. What is the 3:5:10 Rule for ETF?

This is not a standard regulatory rule but a prudent guideline often cited by advisors: Cap individual sector ETFs to 10% of your portfolio, keep tracking error below 5% (benchmark), and aim for expense ratios under 0.3%. It helps maintain diversification and cost-efficiency.

5. What are the current lot sizes for Index Trading?

As of November 2025, the Nifty 50 lot size is 75 units and Bank Nifty is 35 units. However, per NSE circular (Oct 2025), these will reduce to 65 units (Nifty) and 30 units (Bank Nifty) for contracts expiring after December 30, 2025.”