ETFs vs index funds: What’s the difference?

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

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Promoted Finder Score 8.8 Great Interactive Brokers	Finder Score 8.8 Great	Stocks, Bonds, Options, Index Funds, ETFs, Forex, Currencies, Futures	RRSP, TFSA, Personal, Joint	min $1.00, max 0.5%	$0	Go to site More info Compare product selection Compare	loading
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Finder Score 9.1 Excellent Questrade	Finder Score 9.1 Excellent	Stocks, Bonds, Options, Mutual Funds, Index Funds, ETFs, Forex, GICs, Precious Metals, IPOs	RRSP, RESP, RRIF, TFSA, Personal, Joint, FHSA	$0	$0	More info Compare product selection Compare	loading

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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.

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.

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

• Are ETFs better than index funds?

  Some ETFs actually are index funds, so it depends how you look at it. If you're thinking of an index fund as a traditional mutual fund, then both can be advantageous, depending on how you use them.

  The benefit of choosing an ETF is that you can invest small amounts more frequently and easily via a trading app. With a mutual fund, you often need $500 or more as a minimum investment, and you'll need to go through an application process to add more funds or withdraw.

• Can you lose money with an index fund?

  Yes. Like all investments, index funds can go down in value, depending on market performance.

• Are ETFs riskier than index funds?

  Some ETFs are index funds, which can be a moderate-risk stock market investment. However, some ETFs also use leverage or derivatives or track a single commodity, making them very high risk.

• What's the main difference between ETFs and index funds?

  An ETF is an investment product that trades like a stock. An index fund is a fund strategy that involves tracking a market index, and it can be delivered through an ETF or a traditional managed fund like a mutual fund.

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To make sure you get accurate and helpful information, this guide has been edited by Stacie Hurst as part of our fact-checking process.

Written by

Kylie Purcell

Senior investments editor

Kylie Purcell is the senior investments editor at Finder. She has a background in business and finance news with previous roles at SBS, Your Money, TVNZ, Switzer Group and The Adviser magazine. Kylie has a Masters in International Journalism and a Graduate Diploma in Economics. When she's not writing about the markets you can find her bingeing on coffee. " See full bio