An exchange-traded fund (ETF) and index fund are both open-ended mutual fund schemes. However, an ETF is traded on the stock exchange, while index funds are not. This article explores the differences between ETFs and index funds to help investors make informed decisions when investing passively.
Main Differences
There are several differences between ETFs and index funds. Here are some of the main ones:
- Fund Management: Index funds are passive instruments, while ETFs can be either passive or actively managed. This means that an ETF investment company can make tactical decisions on building portfolios. For example, they could choose to invest in technology firms, innovators, health tech, and other tech companies.
- Trading Style: An ETF comes close to a stock in its operations and can be traded the same way on the stock market throughout the day. On the other hand, index funds can be bought or sold at a given price at the end of the trading day.
- Minimum Investments: You can buy ETFs in units, meaning you purchase a certain number of units, such as one unit, eight units, or 100 units. But index funds are bought and traded in the form of an amount.
- Expense Ratio: Both ETFs and index funds have low expense ratios, but ETFs tend to be cheaper.
- Liquidity: While there is no concern about liquidity when you are redeeming index funds, an ETF can have a lack of liquidity. This is because buying an ETF is like buying any other equity share, and if there are no buyers for the units, it can create a problem of liquidity.
Conclusion
Both ETFs and index funds provide enough diversification in the form of tens, hundreds, and thousands of securities. Furthermore, they are both low-cost investment products with potential long-term good returns. Therefore, when making a passive investment, it can be challenging to decide which investment product is better. However, understanding the differences between the two can help investors make informed decisions.