ETF vs Index Funds: The Hidden Costs Behind ‘Low-Cost’ Investing
ETF vs Index Funds: The Hidden Costs Behind ‘Low-Cost’ Investing
Exchange Traded Funds (ETFs) are often promoted as the cheapest way to invest in the stock market due to their low expense ratios. However, a closer look shows that the actual cost of investing in ETFs can be higher than it appears, especially for long-term and small investors.
A growing body of investor experience suggests that plain index mutual funds may, in many cases, be more cost-effective and convenient than ETFs, despite having a slightly higher expense ratio on paper.
Here’s a simple explanation of where the hidden costs lie and who should choose what.
The Invisible Costs of ETFs
ETFs are traded on stock exchanges, similar to shares. While their expense ratio may be low, investors often face additional indirect costs that are not immediately visible.
1️⃣ Entry Cost Through Market Price
Unlike index funds, ETFs are not bought directly from the fund house at NAV. Investors purchase them from the market.
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An ETF with an NAV of ₹100 may trade at ₹104–₹105
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This difference acts like a hidden entry load
Over time, this cost can significantly reduce returns, especially for SIP investors.
2️⃣ Bid–Ask Spread
ETFs are quoted with two prices:
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Bid price (what buyers are willing to pay)
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Ask price (what sellers demand)
Investors usually:
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Buy at the higher ask price
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Sell at the lower bid price
This spread quietly eats into returns, particularly in ETFs with lower trading volumes.
3️⃣ Brokerage and Trading Charges
Every ETF transaction may involve:
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Brokerage
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Exchange charges
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Securities transaction tax (STT)
Index mutual funds, on the other hand, do not involve trading or brokerage costs.
Why Index Funds Appear Costlier but Often Aren’t
Index mutual funds may show a higher expense ratio compared to ETFs. However, in practice:
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Investments are made directly at NAV
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No bid–ask spread
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No brokerage or trading hassle
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Easy SIP execution
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Better suitability for long-term investing
As a result, index funds often deliver more predictable and efficient outcomes for retail investors.
Buy and Sell at NAV: A Key Advantage of Index Funds
With index funds:
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Units are allotted and redeemed at NAV
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No intraday price fluctuations
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No liquidity concerns
This simplicity is particularly beneficial for:
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SIP investors
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First-time investors
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Long-term wealth creators
Who Should Consider ETFs?
ETFs may still be suitable for:
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Experienced investors
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Those who actively track i NAV vs market price
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Traders who monitor liquidity and spreads
Such investors understand how to manage price deviations and trading costs.
Who Should Avoid ETFs?
ETFs may not be ideal for:
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Monthly SIP investors
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Small-ticket investors (₹5,000–₹10,000 SIPs)
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Long-term passive investors seeking simplicity
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Investors who do not actively track market prices
For these investors, plain index mutual funds are often a better choice.
Long-Term Impact on Returns
Over long periods, even small hidden costs can make a big difference.
While ETFs look cheaper due to lower expense ratios, repeated bid–ask spreads, brokerage costs, and price deviations can outweigh those savings. Index funds, despite slightly higher TERs, often result in lower total cost of ownership.
Conclusion
The choice between ETFs and index funds should not be based on expense ratio alone. Investors must look at total cost, ease of investing, and long-term suitability.
For most retail investors focused on steady and peaceful wealth creation, index mutual funds offer a simpler and more efficient route than ETFs.
Mutual Fund investments are subject to market risks. Please read all scheme-related documents carefully before investing. Past performance is not indicative of future returns.
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