ETF cost structure

An ETF and an index fund can track the exact same benchmark and still end up costing an investor different amounts. The gap is not really about the index they follow. It is about how each one is bought and sold.

An ETF trades on the stock exchange, like a share. Every purchase and every sale goes through a broker, needs a demat account, and crosses a bid-ask spread — the small gap between what a buyer is willing to pay and what a seller is willing to accept.

An index fund is bought and sold directly with the fund house at one official price a day. None of that trading friction applies.

The workbook's direct comparison, ETF versus index fund, on cost:

ETF: management costs are comparatively low. But on top of that, every buy and every sell carries brokerage and demat charges, plus the difference between the buy and sell quotes on the exchange — a cost that adds to what is paid on entry and reduces what is received on exit.

Index fund: management costs may be nominally higher than an ETF's. But there are normally no other costs — no brokerage, no demat charges, no bid-ask spread, because units are transacted directly with the AMC at NAV.

Separately, under SEBI's categorisation rules, both an ETF and an index fund face the same 0.90% total expense ratio ceiling, so the "management cost" gap between the two is usually small. The real cost difference an investor feels comes from the transaction layer — trading costs an ETF has and an index fund does not.

An investor wants to put Rs 5,00,000 into a Nifty 50 tracker and compares the two routes.

Via an ETF: buys through a broker at a small premium to NAV, say 0.3% on entry (Rs 1,500), pays brokerage of roughly 0.05% (Rs 250), and will face a similar spread and brokerage again on exit. Ongoing expense ratio: 0.20% a year.

Via the equivalent index fund: buys directly from the AMC at the day's NAV, with no brokerage, no demat charge, and no bid-ask spread on entry or exit. Ongoing expense ratio: 0.30% a year — nominally higher, as the workbook says it may be.

Year 1 running cost, ETF:        5,00,000 x 0.20% = Rs 1,000, plus entry/exit trading costs
Year 1 running cost, index fund: 5,00,000 x 0.30% = Rs 1,500, with no trading costs at all

For a long holding period the ETF's lower expense ratio can still win out, but for an investor trading in and out frequently, the accumulated brokerage and spread cost can easily overtake the annual expense-ratio saving.

Chapter 19 (Comparison of Products across categories), section 19.2.6, "Exchange Traded Funds (ETFs) V/s Index Funds," sets out this exact cost comparison on the "Costs" row of its table. Expect a question asking which product has the lower running cost, or a scenario question where trading frequency changes which of the two options is actually cheaper overall.

• "Lower management cost" for an ETF does not mean "lower total cost." Brokerage, demat charges and the bid-ask spread can outweigh a small expense-ratio saving, especially for smaller or more frequent trades.
• An index fund's slightly higher expense ratio buys the investor no trading costs at all — the comparison is a genuine trade-off, not a one-sided win for either product.
• Both products are capped at the same 0.90% SEBI expense-ratio ceiling — the size of the expense-ratio gap between them is usually small; the trading-cost gap is where the real difference lies.
• Do not confuse cost structure with liquidity — the two are separate rows in the same comparison table, covered in "ETF liquidity in India."