Index funds and exchange-traded funds – or ETFs – appear to be very similar investment vehicles. But look a little harder, and you’ll see subtle differences between the two: differences that should be considered carefully before you choose one or the other. Here, we explain the difference between index funds and ETFs, and how to choose between them.
The similarities between ETFs and index funds
Both index funds and ETFs use the passive indexing strategy: funds are invested in an underlying benchmark index. Essentially, they are designed to passively replicate how an underlying index is performing, rather than being actively managed.
Both fund types allow for portfolio diversification, reducing the impact of significant market swings, tend to have lower fees than actively managed funds, and also often outperform actively managed funds when looking at long term performance. However, there are some key differences between the two.
The differences between index funds and ETFs
Despite their similarities, index funds and ETFs also have some significant differences:
- Trading times: While ETFs are traded in the same way as stock, index funds can only be traded once a day: when their price is set after the market closes.
- Asset types: Index funds will always be associated with and track the performance of a specific market. However, ETFs can include a whole host of different market sectors.
- Fees and investment amounts: Investing minimums are low to zero for ETFs – however, the minimum investment amounts required for index funds may be prohibitive for novice investors. In addition, index fund management fees can be higher.
Your reaction to these differences will likely depend on your investment style, the frequency with which you’re looking to trade, and the markets in which you want to invest. However, both ETFs and index funds will likely be of interest to those who are looking for a passive, long term investment vehicle.
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