Should you switch to ETFs from index funds?

From April 2021 onwards, we have seen a few index funds hiking their expense ratios to almost double than what they used to charge up to March 2021. For instance, Tata Nifty Index Fund has increased its expense ratio from 0.05 per cent to 0.15 per cent, whereas UTI Nifty Index Fund’s expense ratio hiked from 0.1 per cent to 0.18 per cent. In fact, HDFC Mutual Fund is also not back in the race. They too have increased their total expense ratio (TER) of HDFC Nifty and HDFC Sensex Fund from 0.1 per cent to 0.2 per cent. 

Note: All the above-mentioned expense ratios are for direct plans. 

This has definitely proved to be quite shocking for investors, investing in these passive funds. Also, most of them would be thinking about whether exchange traded funds (ETFs) are the way forward for passive investing. 

First of all, investors should understand that mutual funds are here to do business and make profits. Therefore, in no way, they would be thinking before increasing the TER. Further, it is also not a wrong thing to do. However, the point is whether this increase and the new TER justifiable? 

This means that, if the increase in TER is due to inflation, then it’s fine. However, if the same is due to increasing profits, then we need to think again. If we look at the above-mentioned expense ratios, they have doubled. Moreover, we believe that the increase in expense ratio should be in a gradual way and not in a haphazard manner. If this TER continues to rise in a similar manner, then these funds might lose the very purpose of investing in them (low-cost investment). 

What should investors do? 

We would suggest investors to stay put and not act on the increase in TER. This is because this can be temporary in nature. In fact, if the assets under management (AUM) inflows stop, the TER would automatically come down. 

So, does it make sense to shift to ETFs? 

When it comes to ETF, there is no direct or regular plan as such. And TER of ETF is structured in a way wherein, it would always be lower than the index funds. However, should you consider investing in them? Let’s understand. 

For investing in ETF, you need to have a Demat account unlike index funds wherein, you can invest without having a Demat account. Moreover, you need to buy ETFs via a broker. So, there can be a brokerage charge attached to it. Next comes liquidity, which is quite low in ETFs. Though, there are authorised participants (AP) assigned by the fund house for creating additional liquidity. However, they would definitely charge some premium for the same. 

Therefore, knowing all these if you already have a Demat account as well as a knack for trading in stocks, then surely, ETFs are better than index funds. However, for everyone else, investing in index funds makes much more sense.