Finder is committed to editorial independence. While we receive compensation when you click links to partners, they do not influence our content.

ETFs vs index funds

ETFs and index funds are similar, but they have some key differences. Find out what they are and how they're traded.

Once you’ve decided to start investing, there are some choices you need to make, such as between an active and a passive fund. If you chose a passive fund, then you can choose between exchange-traded funds (ETFs) and index funds, but what’s the difference?

In practice, they have a lot in common. They both track an index as closely as possible at a lower cost and bypass the use of an investment manager to pick stocks. However, there are differences in the way they operate that may impact your choice.

Compare platforms to buy ETFs and index funds

1 - 5 of 5
Name Product Brokerage Fee Markets What you can trade?
eToro
IE stocks: No

US stocks: $0
Global
Stocks, ETFs, Currencies, CFDs, Indices, Commodities, Cryptocurrencies
Investing carries a risk of loss
Trade more than 1,000 stocks globally with eToro's social trading and investment platform
Saxo Markets
IE stocks: €12

US stocks: US$7
Global
Stocks, ETFs, Options, Futures, Bonds, Currencies, CFDs, Commodities, Cryptocurrencies
Investing carries a risk of loss
Saxo Markets provides an online platform for trading stocks, shares, CFDs, and forex around the world
DEGIRO
IE stocks: €2

US stocks: $0
Global
Stocks, ETFs, Funds, Options, Futures, Bonds, Cryptocurrencies
Investing carries a risk of loss.
Degiro lets you invest in a variety of financial instruments in different markets around the world.
Until 30 June 2022, pay no transaction fees up to €100 when you make your first transfers as a new Degiro customer. T&Cs apply.
Zacks Trade
IE stocks: No

US stocks: US$1
Global
Stocks, ETFs, Funds, Options, Bonds
Investing carries a risk of loss
The Zachs Trade platform offers stocks, ETFs, bonds, options, and more with access to more than 90 exchanges worldwide
Freedom Finance
IE stocks: €2

US stocks: US$2
Global
Stocks, ETFs, Options, Futures, Bonds
Investing carries a risk of loss
loading

Compare up to 4 providers

What’s an ETF?

ETFs are collections of investments that have been collected together to try and reflect the performance of an index. Think of it like a ready meal from the supermarket that you throw in the microwave. It’s not the same as a takeaway, but it’s a decent substitute, is accessible and comes at a lower cost.

ETFs are generally cheap and liquid (meaning they can be bought and sold easily). They’re available on a vast range of indices, commodities and other asset classes.

All passive funds are low cost, but the largest equity indices ETFs, such as the S&P 500 and MSCI World, are available to investors for an annual fee of less than 0.1%. As the funds have got larger, fees have tended to get cheaper.

ETFs generally have a broader range of investment options than index funds, incorporating currencies, commodities and interest rates. They can also incorporate leverage and it is possible to buy “short” ETFs, where investors can benefit from the falling price in an index. This makes them popular with traders taking short-term positions in markets or looking for nuanced portfolio positioning.

What are index funds?

Index funds are open-ended. This means that changes can be made at any time. This is different to “closed-ended” funds, where the pool of capital remains the same size. Index funds don’t trade on exchange: the shares are priced daily based on their current net asset value.

This means that the net asset value always reflects the price of the underlying assets, unlike closed-ended funds that may trade at a discount or premium to net asset value.

Index funds are refreshingly straightforward. Investors buy directly from the provider or through an investment platform. You know that you’ll get the performance of the index, less any associated fees. Index funds usually track the market through physical replication, which means they buy all the stocks in the index at their exact weighting in the index. Where this isn’t possible, some providers may use “sampling” to track the index, meaning they buy key stocks whose performance closely resembles that of the index.

ETFs vs index funds: The similarities

  • Track an index or equity. Both ETFs and index funds aim to replicate the performance of an equity or index as closely as possible without the intervention of an investment manager.
  • Less risk. ETFs and index funds both hold less risk than individual stocks and bonds.
  • They track the same indices. ETFs and index funds hold many of the same indices, such as the S&P 500 or the FTSE All-Share.
  • Plenty of investment options. Both offer a wide choice of markets and asset classes.
  • Costs. Both ETFs and index funds aim to reduce costs for the investor.

ETFs vs index funds: The differences

  • History. Passive funds have been around for much longer than ETFs. Vanguard’s Jack Bogle launched the first passive fund in 1975, while ETFs have only been around since 1993, when State Street launched its first SPDR ETF, also based on the S&P 500.
  • Index funds are more widespread. This is despite ETFs having had a bit of momentum in recent years.
  • Buying and selling. ETFs are bought and sold on an exchange, which means investors get an instant price and make the transaction according to the settlement terms of the exchange. Index funds only trade once a day, and it can take a few days to liquidate a position and settle it.
  • Timescales. Due to the way they are traded, index funds tend to suit longer-term investors, whereas ETFs tend to suit those who like to trade more flexibly.
  • Minimum investment levels. For index funds, the minimum investment will generally be higher. For ETFs, it may be as little as €50, but it can be €3,000 or more for index funds.

ETFs vs index funds: Fees

Broker fees
Because ETFs trade like normal shares, investors need to pay a broker fee each time they make a transaction. Depending on the platform, this can mount up, which can make them a poor choice for regular savers trying to put small amounts to work every month – the dealing costs can end up being a disproportionate amount of the overall investment.

Bid-offer spread
With ETFs, investors also need to factor in the bid-offer spread (the gap between the price at which the broker is prepared to buy and sell). This is usually very small for large, liquid ETFs based on major indices, but can widen out for smaller ETFs.

Annual management fee
For both ETFs and index funds, investors may pay a small annual management fee plus any fee for holding the funds on an investment platform.

The difference in the annual management fee between ETFs and their index fund equivalent is relatively small.

Rebalancing costs
Open-ended funds need to rebalance constantly to adjust for inflows and outflows. This creates some trading costs. This doesn’t happen with ETFs, which have a unique process called creation/redemption in-kind where shares of ETFs are created and redeemed with a like-for-like basket of securities. This means ETFs don’t have these transaction costs.

Cash drag
Open-ended funds need to hold some cash to meet redemptions. This is cash that is not at work in the market and not earning dividends at any given moment. While this may benefit an index fund at times when the market is falling, for the most part, it will exert a small drag effect on returns.

Dividend policy
Index funds reinvest dividends immediately (unless the unitholder is holding income units, in which case they are paid out). The nature of ETFs means that dividends need to be held in cash until the end of the quarter. This can make a difference if dividends are high and shares prices are rising quickly.

ETFs vs index funds: Which is for me?

Neither of these is necessarily better than the other. The right option will depend on you, your circumstances and your investment ambitions. However, it is possible to make some general points:

ETFs will tend to suit

  • An investor who wants to move in and out of the market quickly
  • Those who want to trade short-term movements or with leverage
  • Those who want the widest possible choice of asset classes
  • Those with small amounts to invest
  • Those who want fully transparent pricing

Index funds will tend to suit

  • Long-term investors or those saving small amounts regularly
  • Those investing in higher dividend areas
  • Those with larger amounts to invest
  • Those looking to invest in mainstream indices

In summary

In practice, the difference between the returns from an ETF and from an index fund from the same provider is likely to be minimal. Costs and performance are likely to be similar. The real decision is on the type of investor you are and on how the fund will be bought and sold.

warning iconWarning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 83.45% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work, and whether you can afford to take the high risk of losing your money.
Disclaimer: 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 all investors. Trading CFDs and forex on leverage comes with a higher risk of losing money rapidly. Past performance is not an indication of future results. Consider your own circumstances, and obtain your own advice, before making any trades.

More guides on Finder

Ask an Expert

You are about to post a question on finder.com:

  • Do not enter personal information (eg. surname, phone number, bank details) as your question will be made public
  • finder.com is a financial comparison and information service, not a bank or product provider
  • We cannot provide you with personal advice or recommendations
  • Your answer might already be waiting – check previous questions below to see if yours has already been asked

Finder.com provides guides and information on a range of products and services. Because our content is not financial advice, we suggest talking with a professional before you make any decision.

By submitting your comment or question, you agree to our Privacy Policy and Terms.

Questions and responses on finder.com are not provided, paid for or otherwise endorsed by any bank or brand. These banks and brands are not responsible for ensuring that comments are answered or accurate.
Go to site