Index Fund vs. ETF: What's the Difference? (2024)

Index Fund vs. ETF: An Overview

Exchange-traded funds (ETFs) and index funds are similar in many ways but ETFs are considered to be more convenient to enter or exit. They can be traded more easily than index funds and traditional mutual funds, similar to how common stocks are traded on a stock exchange.

Investors can also buy ETFs in smaller sizes and with fewer hurdles than mutual funds. They can avoid the special accounts and documentation required for mutual funds by purchasing ETFs.

Key Takeaways

  • Mutual funds are pooled investment vehicles managed by a money management professional.
  • Exchange-traded funds (ETFs) represent baskets of securities that are traded on an exchange like stocks.
  • ETFs can be bought or sold at any time.
  • Mutual funds are only priced at the end of the day.
  • Overall, ETFs cost less and are more tax-efficient than similar mutual funds.

Index Mutual Funds

Index funds are funds that represent a theoretical segment of the market. They're designed to act as the performance and make-up of a financial market index. You can't invest in an index itself but you can invest in an index fund. You're utilizing a form of passive investing that sets rules by which stocks are included and then tracks the stocks without trying to beat them.

These types of funds follow a benchmark index like the Nasdaq 100 or S&P 500. Index funds have lower expenses and fees than funds that are actively managed.

Those who are interested in investing in an index fund can generally do so through a mutual fund that's designed to mimic the index.

Exchange-Traded Funds (ETFs)

ETFs are baskets of assets that are traded like securities. They can be bought and sold on an open exchange just like regular stocks. Mutual funds are only priced at the end of the day.

Other differences between mutual funds and ETFs relate to the costs associated with each. There are typically no shareholder transaction costs for mutual funds. Costs such as taxation and management fees, however, are lower for ETFs. Most passive retail investors choose index mutual funds over ETFs based on cost comparisons between the two. Passive institutional investors tend to prefer ETFs.

More ETF options are available beginning in 2024 and this might make them a more attractive investment. TheSecurities and Exchange Commission(SEC) approved 11 new ETFs to be listed on
the NYSE Arca, Cboe BZX, and Nasdaq exchanges beginning on Jan. 11, 2024. These are the first spot market bitcoin ETFs to ever be listed.

Financial experts consider index fund investing to be a rather passive investment strategy compared to value investing.

Value investing often appeals to investors who are persistent and willing to wait for a bargain to come along. Getting stocks at low prices increases the likelihood of earning a profit in the long run. Value investors question a market index and usually avoid popular stocks in hopes of beating the market.

Advisor Insight

Will Thomas, CFP®, CIMA®, CTFA
The Liberty Group, LLC, Washington, DC

The confusion is natural, as both are passively managed investment vehicles designed to mimic the performance of other assets.

An index fund is a type of mutual fund that tracks a particular market index: the S&P 500, Russell 2000, or MSCI EAFE (hence the name). Because there’s no original strategy, not much active management is required and so index funds have a lower cost structure than typical mutual funds.

Although they also hold a basket of assets, ETFs are more akin to equities than to mutual funds. Listed on market exchanges just like individual stocks, they are highly liquid: They can be bought and sold like stock shares throughout the trading day, with prices fluctuating constantly. ETFs can track not just an index, but an industry, a commodity, or even another fund.

What Is the Difference Between an ETF and an Index Fund?

The main difference between an ETF and an index fund is that ETFs can be traded during the day and index funds can only be traded at the set price point at the end of the trading day.

Do ETFs or Index Funds Have Better Returns?

ETFs and index funds have both performed well historically. It may be wise to check the overall costs of each and compare them before you decide where to invest your money.

Are ETFs or Index Funds Safer?

Neither an ETF nor an index fund is safer than the other because it depends on what the fund owns. Stocks will always be riskier than bonds but will usually yield higher returns on investment.

The Bottom Line

Both index mutual funds and ETFs can provide investors with broad, diversified exposure to the stock market, making them good long-term investments suitable for most investors. ETFs may be more accessible and easier to trade for retail investors because they trade like shares of stock on exchanges. They also tend to have lower fees and are more tax-efficient.

Index Fund vs. ETF: What's the Difference? (2024)


Index Fund vs. ETF: What's the Difference? ›

The biggest difference between them is that ETFs trade intraday at various prices during exchange hours and index mutual funds can be bought or sold only after the market closes each day, at a fund's net asset value.

Is it better to invest in ETF or index fund? ›

ETFs and index mutual funds tend to be generally more tax efficient than actively managed funds. And, in general, ETFs tend to be more tax efficient than index mutual funds. You want niche exposure. Specific ETFs focused on particular industries or commodities can give you exposure to market niches.

Should I have both index fund and ETF? ›

Both Index Funds and ETFs offer investors unique advantages and cater to different investment preferences. While index funds provide simplicity, stability, and cost-effectiveness for long-term investors, ETFs offer greater flexibility, intraday trading options, and potential for active management strategies.

Why is ETF cheaper than index? ›

For most investors, ETF trades take place with other investors, and not with the fund company itself. That means the fund company doesn't have to process your order; doesn't have to mail you the same documents; and doesn't have to go into the market to process your order. Less work = lower costs.

What is better a S&P 500 ETF or mutual fund? ›

The choice comes down to what you value most. If you prefer the flexibility of trading intraday and favor lower expense ratios in most instances, go with ETFs. If you worry about the impact of commissions and spreads, go with mutual funds.

Is the S&P 500 an ETF or index fund? ›

While an S&P 500 index fund is the most popular index fund, they also exist for different industries, countries and even investment styles. So you need to consider what exactly you want to invest in and why it might hold opportunity: Location: Consider the geographic location of the investments.

Why would you choose an index fund over an ETF? ›

Passive retail investors often choose index funds for their simplicity and low cost. Typically, the choice between ETFs and index mutual funds comes down to management fees, shareholder transaction costs, taxation, and other qualitative differences.

What are 2 cons to investing in index funds? ›

The benefits of index investing include low cost, requires little financial knowledge, convenience, and provides diversification. Disadvantages include the lack of downside protection, no choice in index composition, and it cannot beat the market (by definition).

Is it OK to only invest in index funds? ›

Investing legend Warren Buffett has said that the average investor need only invest in a broad stock market index to be properly diversified. However, you can easily customize your fund mix if you want additional exposure to specific markets in your portfolio.

Do index funds pay dividends? ›

Most index funds pay dividends to their shareholders. Since the index fund tracks a specific index in the market (like the S&P 500), the index fund will also contain a proportionate amount of investments in stocks. For index funds that distribute dividends, many pay them out quarterly or annually.

Are index funds taxed? ›

Index mutual funds & ETFs

Constant buying and selling by active fund managers tends to produce taxable gains—and in many cases, short-term gains that are taxed at a higher rate.

Do ETFs pay dividends? ›

One of the ways that investors make money from exchange traded funds (ETFs) is through dividends that are paid to the ETF issuer and then paid on to their investors in proportion to the number of shares each holds.

Are ETFs better than index funds for taxes? ›

If you're investing in a taxable brokerage account, you may be able to squeeze out a bit more tax efficiency from an ETF than an index fund. However, index funds are still very tax-efficient, so the difference is negligible. Don't sell an index fund just to buy the equivalent ETF.

What is the downside of ETFs? ›

For instance, some ETFs may come with fees, others might stray from the value of the underlying asset, ETFs are not always optimized for taxes, and of course — like any investment — ETFs also come with risk.

Do you pay taxes on ETFs if you don't sell? ›

At least once a year, funds must pass on any net gains they've realized. As a fund shareholder, you could be on the hook for taxes on gains even if you haven't sold any of your shares.

What is the best ETF for a first time investor? ›

Related Tickers
IVViShares Core S&P 500 ETF0.614%
BNDVanguard Total Bond Market ETF0.297%
SCHDSchwab U.S. Dividend Equity ETF0.221%
VTIVanguard Total Stock Market ETF0.71%
5 more rows

What is a disadvantage to investing in index funds? ›

Lack of Downside Protection

Investing in an index fund, such as one that tracks the S&P 500, will give you the upside when the market is doing well, but also leaves you completely vulnerable to the downside.

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