Difference Between ETF vs Index Funds
What are ETF’s?
“Exchange-Traded Funds” or ETF’s are funds which are traded on the exchange (as the name goes), and which act like a fund consisting of underlying assets, like stocks, bonds, commodities and sometimes Index funds themselves. The logic is that they rely on an index, and are valued based upon the movement of such index. However, they are very liquid in nature, and for investing in them, one needs to pay a small fee. This concept has similarities with mutual funds, however, these are more liquid and charge lesser fees than mutual funds – which is why they are more traded than mutual funds. ETF’s are traded like regular stocks in the market due to their liquidity.
What are Index Funds?
“Index Funds” are a type of exchange-traded mutual fund, which follows a particular index, track the movement of the same, and are valued based upon such an index. These are traded at the exchange and are closely linked to the particular index they follow. Generally, index funds with underlying assets being stocks, follow a mix of different companies that are large sized, mid-sized, small sized, profitable, risky, etc. in definite proportions in order to balance the portfolio. They perform as mutual funds and a subset of the ETF’s. Like mutual funds, these funds are managed by portfolio managers, and investors can purchase these from such managers. They are easy to track being traded on an exchange, and thus are widely traded into. The most commonly traded Index Fund is S&P 500 Index Fund.
ETF vs Index Funds Infographics
Below is the top 6 difference between ETF vs Index Funds
Key Difference Between ETF vs Index Funds
Both ETF vs Index Funds are popular choices in the market; let us discuss some of the major Difference Between ETF vs Index Funds:
- One major benefit of both ETF vs Index Funds is that they are both superior to trading the underlying asset alone. As they form a mix of different assets and often get valued based on the index as a whole, they are less riskier to the individual underlying asset.
- Both ETF vs Index Funds are easy to invest into, as they are exchange-traded, and have a benefit of being regulated – hence less risky.
- Easy to track – once again, as they are exchange-traded, they are easy to track.
- Investing into ETF’s and Index Funds incurs lower costs.
- Both ETF vs Index Funds allow diversification of risk as they follow the particular index, and not any particular company or sector or industry. A diversified portfolio has its own benefits – less risky, more reliable, more profitable and more stable to economic changes.
- As the costs incurred are lower to other funds, both ETF vs Index funds attract lower tax implications, which again make them preferable to other types of funds.
- By investing into ETF or Index Funds, one can relate the performance of various different industries and sectors to each other, and thus make their analysis as to creating the right balance of their investments.
- Once you invest into an ETF or Index Fund, you are not entitled to the ownership of the underlying stock, however, you get a share of profits or earned dividends declared by the companies.
- Both ETF vs Index Funds are capable of generating greater profits in the longer horizon, than those compared to individual stocks. Individual stocks are seldom maintained for a long-term purpose, and likewise, all analysis is also prepared accordingly. However, these type of funds is invested into with long-term vision of profits.
Head To Head Comparison between ETF vs Index Funds
Below is the topmost comparison between ETF vs Index Funds
|Exchange Traded Funds||Index Funds|
|This is the superset being traded at exchanges – includes underlying assets like stocks, commodities, bonds, and sometimes index funds themselves.||This is a subset being traded in the market – is also called as an ETF, however, an ETF may or may not always be an Index Fund.|
|More liquid than an Index Fund, as they cover a larger range of underlying assets, and hence a larger (or almost the whole) market. Hence people prefer to invest in such funds.||Less liquid than ETF, as they target a particular index, and companies that are a part of such an index. Hence, the lesser scope of market analysis.|
|Higher costs associated with an ETF than Index Funds. Hence even-though, they offer a larger palette of analysis, investors think twice before investing in these.||Lower costs of investment and maintenance for Index Funds, make them easy to invest into.|
|ETF’s have a lower tracking error risk. Any index has a particular proportion of companies, and the fund tries to track the same proportion for itself. However, since the exact proportion match is not possible with the index, it creates a tracking error risk for investors.||Index Funds have a higher tracking error risk associated with them, as a particular fund will depend upon one particular index. There is no chance of diversification, and hence all the tracking error risk possible will hit the particular fund completely.|
|As ETF’s are traded like stocks at exchanges, they do not have a NAV. They are traded during the day like stocks and priced accordingly.||Index Funds are bought during the trading hours and sold at end of the day NAV based on the fund’s performance.|
|As ETF’s are traded like stocks, they imbibe a lot of characteristics of individual stocks, like valuation (pricing the fund), dividend payment, a redemption of stock or payment done to investors at residual value of the stock after liquidation.||Index Funds take up the characteristics of a mutual fund, like pricing based on NAV (Net Asset Value), underlying assets being traded as units, plans offered by mutual funds for reinvestment, and likewise reinvesting the earned profits into such plans.|
ETF vs Index Funds – Final Thoughts
Although ETF vs Index Funds seems similar at the time of investment, there lie quite significant differences in the calculation of returns (and risks). Hence, one should read all the terms and conditions of the offered documents and then invest to maximize returns and lower their risks.
This has a been a guide to the top difference between ETF and Index Funds. Here we also discuss the ETF vs Index Funds key differences with infographics, and comparison table. You may also have a look at the following articles –