ETFs vs index funds: What’s the difference?
An ETF might be an index fund or it can follow a completely different investment strategy.
Key takeaways
- ETFs and index funds can follow the same strategy, but they’re not always the same thing.
- ETFs are traded on the stock market in real-time; index funds are often bought directly from a fund manager.
- An ETF is a type of investment product, while an index fund refers to an investment strategy.
It’s one of the most common investing questions out there: What’s the difference between an ETF and an index fund?
You’ll often hear these terms used interchangeably, and that’s not necessarily wrong, but it’s not always right either. Sometimes an ETF is an index fund, sometimes it’s not. And not all index funds are ETFs.
Confused? Don’t worry—in this guide, we’ll break down key differences between the two, how each works, how much they cost and how to find one that suits your investing style.
How ETFs and index funds work
An index fund is an investment fund that tracks a specific index like the S&P 500 or the S&P/TSX Composite or S&P 500. It buys most or all of the stocks in that index, so your returns follow the market.
An ETF (exchange-traded fund) is a type of investment product you can buy and sell on a stock exchange, just like a stock. Many ETFs track an index (making them index funds), but some are actively managed or follow different strategies.
So, while all index fund ETFs are ETFs, not all ETFs are index funds. Likewise, not all index funds are ETFs—some are traditional, managed funds.
Sometimes, you’ll have the option of investing in an index fund ETF or the exact same mutual fund.
ETF vs Index Fund Comparison
| Feature | ETF | Index Fund |
|---|---|---|
| Structure | Traded like stocks on an exchange (TSX, NYSE etc.) | Can be an ETF or managed fund |
| Pricing | Real-time | Once daily (for mutual funds) |
| Strategy | Passive or active | Usually passive |
| Access | Through a brokerage | Through a manager or platform |
What are passive and active strategies?
A fund that follows a passive investing strategy simply tracks an index with little to no involvement from fund managers. For example, an S&P 500 index fund will mirror the movements of the S&P 500.
An active strategy is one in which fund managers actively buy and sell assets in an attempt to beat an index (called beating the market). Many funds now use a combination of both passive and active strategies, where fund managers track an index but actively buy and sell stocks as needed.
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How do you invest in ETFs and index funds?
ETFs are easier to access if you have a small investment amount, as there’s usually no minimum amount to buy in.
A number of platforms, like National Bank Direct Brokerage and Interactive Brokers, let you open an account with no minimum required deposit, and you won’t be charged a commission for trading ETFs.
Mutual funds that track an index often require a minimum of $500 or more and must be purchased directly through the fund manager.
What are the fees to access ETFs and index funds?
There are three main fees you need to worry about when investing in ETFs and managed funds, including index funds—management fees, trade fees and performance fees.
Management fees
Both ETFs and index-tracking mutual funds charge a management fee, which is a percentage of your overall portfolio. This fee is typically between 0.25% and 1.50%.
ETF management fees are often cheaper than mutual funds, but this usually depends on the overall strategy of the fund. Passive index funds typically have the lowest management fees, while actively managed funds or more complex funds will charge a higher fee.
Related: Best ETFs in Canada for 2025
Trade fees (brokerage)
These are the fees you pay whenever you’re transferring money into (or out of) your investment fund.
If you’re investing in an ETF, you’ll need to pay a brokerage fee to whichever platform you’re using to access that ETF. Brokerage fees range enormously, typically between $0–$10, depending on the platform you use. It’s worth noting that some platforms offer $0 brokerage deals for ETFs but charge a sell fee or a monthly account fee.
If you’re investing in an index-tracking mutual fund, you wont need to pay a brokerage fee, however your initial investment might need to be higher than with an ETF, and you may also need to pay a higher management fee.
Performance fees
Some investment funds, including ETFs and some more complex index funds, charge a performance fee in addition to the management fee.
This fee is usually charged as a small percentage of any returns your fund makes above and beyond its goal of beating the market. It’s worth checking if your investment fund charges this (check the Fund Facts), because this fee can eat into your returns, even if the fund appears to be performing well.
How do ETFs and index funds perform?
How an index fund performs depends on how the index it’s tracking performs.
For example, the iShares S&P/TSX 60 Index ETF (XIU), which tracks an index of 60 large companies on the TSX, has returned just under 15% per year on average over the last five years, closely mimicking the S&P/TSX 60 index—although it will never be exactly the same.
However, ETFs can follow many different investment strategies, and not all are passive index funds like XIU.
For example, some ETFs track the bond market, which is very low risk, but also offers very low returns, typically less than 5%. Other ETFs track commodities, like gold or oil, which may perform very well in some years, but poorly in others.
Some of the worst-performing ETFs can be quite complex and risky, using leverage (borrowed funds) to maximize returns (and losses).
For this reason, make sure to check the investment strategy and pair it with your risk profile before investing.
Tax implications of ETF and index funds
ETFs can be more tax-efficient than traditional, index-tracking mutual funds, because of how they’re structured and how trades are handled internally within the fund.
Mutual funds often need to sell assets to raise cash when investors redeem their units. This can trigger a capital gains tax event inside the fund, which is then passed on to all investors as a taxable distribution, even if you didn’t sell anything yourself.
ETFs, however, use a process called “in-kind redemption.” When investors want to redeem ETF shares, the fund can hand over the underlying stocks directly without selling them. This reduces the need to sell on the open market, which in turn helps minimize taxable capital gains for all ETF holders.
Both product types can pay dividends, and both are also subject to capital gains tax if sold for a profit.
Tip: Consider using DRIPs (dividend reinvestment plans) to compound returns
Dividend Reinvestment Plans (DRIPs) let you automatically reinvest your dividends into more units of the fund instead of receiving cash.
- With ETFs, you’ll need to check if a DRIP is available through the ETF provider. You’ll usually need to apply yourself through the ETF’s share registry.
- With mutual funds, the fund manager applies the DRIP directly and reinvests dividends into the fund on your behalf.
Index funds vs ETFs—How Alex saved on fees
Alex had $10,000 to invest. He compared the BMO NASDAQ 100 Equity Index ETF (ZNQ) and the BMO Nasdaq 100 Equity ETF Fund (Series A) mutual fund. Over one year:
- ETF: $5 brokerage fee + 0.39% management fee = $44
- Mutual fund: no brokerage fee + 0.94% fee = $94
Alex plans to invest once a year for at least the next five years, although he’d like the option to invest more often if he can.
In the end, Alex chose the ETF because, even though he had to pay a brokerage fee, he liked the flexibility of being able to add small amounts whenever he liked. And, because the management fee was higher with the unlisted index fund, this largely offset what he would pay in brokerage fees with the ETF.
Choosing the ETF potentially saved him in fees and gave him ultimate flexibility to buy and sell when he chose.
What’s best for you?
- Suitable for beginners or frequent investors: ETF
- Suitable for high net worth or autopilot portfolios: Index-tracking mutual fund
- Our verdict: ETFs suit most Canadian investors because of ease of access and flexibility, but mutual funds that track indices are better for long-term, buy-and-hold investors who prefer minimal interaction.
Index fund vs ETF: FAQs
Important information: Powered by Finder.com. This information is general in nature and is no substitute for professional advice. It does not take into account your personal situation. This information should not be interpreted as an endorsement of futures, stocks, ETFs, CFDs, options or any specific provider, service or offering. It should not be relied upon as investment advice or construed as providing recommendations of any kind. Futures, stocks, ETFs and options trading involves substantial risk of loss and therefore are not appropriate for most investors. You do not own or have any interest in the underlying asset. Capital is at risk, including the risk of losing more than the amount originally put in, market volatility and liquidity risks. Past performance is no guarantee of future results. Tax on profits may apply. Consider the Product Disclosure Statement and Target Market Determination for the product on the provider's website. Consider your own circumstances, including whether you can afford to take the high risk of losing your money and possess the relevant experience and knowledge. We recommend that you obtain independent advice from a suitably licensed financial advisor before making any trades.
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