Etfs vs index funds Comparing the Costs ETFs and index funds each have their own particular

advantages and disadvantages when it comes to costs associated with index tracking (the ability to track the performance of their respective index) and trading. The costs involved in tracking an index fall into three main categories. A direct comparison of how these costs are handled by ETFs and by index funds should help you make an informed decision when choosing between the two investment vehicles. First, the constant rebalancing that occurs with index funds because of daily net redemptions results in explicit costs in the form of commissions and implicit costs in the form of bid-ask spreads on the subsequent underlying fund trades. ETFs have a unique process called creation/redemption in-kind (meaning shares of ETFs can be created and redeemed with a like basket of securities) that avoids these transaction costs. Second, a look at cash drag - which can be defined for index funds as the cost of holding cash to deal with potential daily net redemptions - favors ETFs once again. ETFs do not incur this degree of cash drag because of their aforementioned creation/redemption inkind process. Third, dividend policy is one area where index funds have a clear advantage over ETFs. Index funds will invest their dividends immediately, whereas the trust nature of ETFs requires them to accumulate this cash during the quarter until it is distributed to shareholders at end-of-quarter. If we were to return to a dividend environment like that seen in the 1960s and '70s, this cost would certainly become a bigger issue. Non-tracking costs can also be divided into three categories: management fees, shareholder transaction costs and taxation. First, management fees are generally lower for ETFs because the fund is not responsible for the fund accounting (the brokerage company will incur these costs for ETF holders). This is not the case with index funds. Second, shareholder transaction costs are usually zero for index funds, but this is not the case for ETFs. In fact, shareholder transaction costs are the biggest factor in determining whether or not ETFs are right for an investor. With ETFs, shareholder transaction costs can be broken down into commissions and bid-ask spreads. The liquidity of the ETF, which in some cases can be material, will determine the bid-ask spread. Finally, the taxation of these two investment vehicles favors ETFs. In nearly all cases, the creation/redemption in-kind feature of ETFs eliminates the need to sell securities - with index mutual funds, it is that need to sell securities that triggers tax events. ETFs can also rid themselves of capital gains inherent in the fund by transferring out the securities with the highest unrealized gains as part of the redemption in-kind process.

Table 2 - A comparative look at the costs associated with index funds and ETFs, with 1 indicating the greatest effect on costs and 4 the least. Which Investment Will You Choose? Typically, the choice between ETFs and index funds will come down to the most important issues: management fees, shareholder transaction costs, taxation and other qualitative differences. According to the analysis we mentioned earlier by Kostovetsky, a comparison of these costs favors index funds as the choice for most passive retail investors. Kostovetsky's analysis assumes no tracking costs and the more popular indexes. For example, if you were looking at a holding period of one year, you would be required to hold over $60,000 of an ETF for the management fee and taxation savings to offset the transaction costs. With a longer-term time horizon of 10 years, the break-even point would be lowered to $13,000. However, both these limits are usually out of range for the average retail investor. Conclusion As with many financial decisions, determining which investment vehicle to commit to comes down to "dollars and cents". Given the comparison of costs, the average passive retail investor will decide to go with index funds. For these investors, keeping it simple can be the best policy. Passive institutional investors and active traders, on the other hand, will likely be swayed by qualitative factors in making their decision. Be sure you know where you stand before you commit.
Equity linked saving schemes are a kind of mutual funds like diversified equity funds with Tax benefits. It is just like other tax saving instruments like National Savings Certificate and Public Provident Fund. Main advantage with ELSS is lock-in period is only 3 years while for NSC it is 6 years and for PPF it is 15 years. At the same time risk factor is high in ELSS. As per Income Tax act 80c investment up to Rs 1,00,000 are eligible for deduction from the gross total income hence reducing the total taxable income. For example if

your total annual income is Rs 3,00,000 and you invest Rs 1,00,000 in ELSS then your taxable income will become Rs 2,00,000.

Previously there was an upper limit for investing in tax saving instruments like ELSS of 5,00,000. Only individuals with less than 5,00,000 annual income are allowed to invest in tax saving instruments. But last year financial budget removed this restriction and now any individual can invest in ELSS irrespective of their income level. Advantages of ELSS over NSC and PPF 1. Main advantage of ELSS is its short lock-in period. Maturity period of NSC is 6 years and PPF is 15 years. 2. Since it is an equity linked scheme earning potential is very high. 3. Investor can opt for dividend option and get some gains during the lock-in period 4. Investor can opt for Systematic Investment Plan 5. Some ELSS schemes also offer personal accident death cover insurance 6. Provides 30 to 40% returns compared to 8% in NSC and PPF Disadvantages of ELSS 1. Risk factor is high compared to NSC and PPF 2. Premature withdrawal is not allowed but it is allowed in other instruments in some specific conditions.

Diversified Equity Schemes and ELSS Both Equity linked saving scheme and diversified equity scheme operates in same way. Both are high return and high risk schemes. But there is a 3 year lock in period of ELSS and it provides tax benefits too. Systematic Investment Plan Best way to invest in ELSS is through Systematic Investment Plan(SIP). With SIP you can invest a small amount every month for a specific time period. With SIP investor can take advantage of fluctuations in the stock market. So investor will get more units when the market is down and get less units when the market is up. For eg if you are investing Rs 1000 every month and you will get 100 units for when Net Asset Value (NAV) is 10 and will get 50 units when NAV is 20. So investing a fixed sum regularly helps to cover the market fluctuations by rupee costs averaging. Also most of the Asset Management Companies (AMC) charges less entry load for SIP compared to normal purchase.

Advantages of ELSS

Lock-in for three years prevents unnecessary withdrawals and allows your money to grow over a period of time

Investments in equity over a long-term delivers better returns than that of other savings instruments and similar to other equity schemes Tax savings and high returns Flexibility to Invest in small amounts through a Systematic Investment Plan