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

FAQs

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.

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.

Investing in both index funds and ETFs can be beneficial, as they offer different advantages. While there may be some overlap in the investments they hold, there can still be value in holding both.

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.

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.

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.

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.

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).

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.

Dividend index funds can be mutual funds or exchange-traded funds (ETFs). Investors can select an index that includes multiple dividend-paying stocks. They generally provide steady income instead of high growth.

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.

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.

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.

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.

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.

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.