ETF vs Index Fund: What's the difference? (2023)

Instead of trying to beat the market, many people opt for it.sonthe market by investing in passively managed funds.

Long-term,passive investmentvehicles, such as exchange-traded funds (ETF) Inindex funds— consistently outperforming the vast majority of active funds, making them a great choice for most investors. So what is the difference between them?

Related: How to invest in index funds

ETF vs Index Fund: Similarities

All index funds and most ETFs use the same strategy: passive index investing. This approach passively seeks to track the performance of an underlying index, allowing for easy diversification and long-term sustainable returns.


Index funds and ETFs provide an easy way to diversify your portfolio. Both offer exposure to hundreds or even thousands of securities, depending on which index they target. This can significantly reduce the chance that your portfolio will be negatively affected by major market swings.

Individual stock prices can fluctuate wildly from day to day, but the ASX loses or gains less than 1% per day on average. Investing in an index fund or ETF that tracks the ASX 200 won't protect you from all or any losses, but it will reduce the risks and volatility you'd experience if you owned just a few individual stocks.

Long-term sustainable benefits

Index funds and broad, passively managed ETFs have outperformed actively managed mutual funds over the long term.

An elite minority of active managers can achieve impressive results in a shorter period of time by picking individual stocks, but it is extremely rare that they can maintain a winning record for decades. According to S&P Global, more than 87% of actively managed funds have underperformed their benchmark indices over the past 15 years.

What does that mean for your investment in an index fund or ETF?

(Video) Index Funds vs ETFs vs Mutual Funds - What's the Difference & Which One You Should Choose?

Over the past 10 years, the ASX 200 has achieved an average total return of 9.3% per year. By buying the ASX 200 or another stock index fund, your investments will grow over the long term.

location cost

Index funds and index ETFs generally have much lower expense ratios than actively managed funds. The US Institute of Investment Firmsmost recent research on the ratio of expensesanalyzed the average expense ratios of actively managed stock funds versus stock index funds and stock index ETFs and found:

  • Actively managed mutual funds charged around 0.74% on average.
  • Stock index funds charged an average expense ratio of 0.07%.
  • Stock index ETFs charged an average expense ratio of 0.18%. (However, it's not uncommon to see index ETFs with much lower expense ratios.)

While they may seem insignificant, expense ratios over time can really erode your overall returns. Assuming you invested $6,000 a year for 30 years and earned an average annual return of 6%, investing in the average index fund would save you almost $60,000 over the cost of the average actively managed mutual fund.

Passive index investing lowers your overall costs and puts more of your money to work in your portfolio.

Related: Best iShare ETFs for Australians

ETF vs. Index Fund: Differences

One of the main differences between an index fund and ETFs is how they are traded. ETF shares trade like stocks; they are bought and sold when the markets are open. While you can order index fund shares at any time, share purchases only occur once a day, after the markets close. This means that the price of an ETF fluctuates throughout the trading day, while the price of an index fund only changes once a day.

business costs

While both index funds and ETFs have low expense ratios, additional expenses beyond the expense ratio can look very different.

Most brokers have waived trading fees for nearly all stock transactions, and many also do not charge fees for ETF transactions. Meanwhile, the sales commissions of an index fund broker can be very expensive. That being said, online brokers generally offer a selection of funds with no commissions. There is simply no guarantee that the funds you choose to buy will be commission free.

Then there's the upload fee, another form of sales commission. Upfront fees may be charged for the purchase of funds, while backload fees may be charged for the sale of funds. Freight costs can be a percentage of your total purchase or a fixed amount. ETFs have no loading fees at all.

Therefore, a particular ETF may charge a higher annual expense ratio than a targeted index fund, but you should consider the potential commissions and sales charges charged by a comparable index fund.

Minimum investment amounts

Many index funds have minimum investment requirements, sometimes in the thousands of dollars. ETFs have no minimum purchase requirements.

(Video) Index Funds vs Mutual Funds vs ETF (WHICH ONE IS THE BEST?!)

While some index fund providers have lower minimums if you make regular contributions to a tax-advantaged retirement account, they can still be significant.

fractional shares

Until recently, most ETFs weren't available as broken stocks (depending on your brokerage, they may not be yet). Index funds, on the other hand, have always been available in fractions.

When you buy an index fund, the managers convert the dollar value of your investment into the appropriate number of shares based on the net asset value on the day of your purchase, whether or not you get a fractional share.

Fractional shares have the potential to help you get your money to market faster by allowing you to buy parts of entire fund shares instead of buying more expensive whole shares. This also allows you to take better advantage of dollar cost averaging, allowing you to pay less per share overall over time.

tax implications

ETFs are typically more tax-efficient than managed funds and generally incur lower capital gains tax (CGT) compared to more frequently traded actively managed funds . Although you pay capital gains tax on the gains you make when you sell shares of an index fund or ETF, you don't pay tax when managers adjust ETF portfolio positions. In fact, tax efficiency is one of the great draws of ETFs.

Meanwhile, index funds must buy and sell assets to adjust their portfolio to track the underlying index. The cost of any capital gains tax on these sales is deducted from the fund's portfolio NAV, which affects the value of your index fund's shares. That being said, index fund positions rarely change, so this may not be a big problem for you.

In both cases, check with your accountant orFinancial Advisorfor more information on how taxes, including capital gains tax, apply to ETFs and index funds, as this is a tricky area.


ETFs are rarely available as investment options in defined contribution plans, such aspensionmoney. In general, index funds and actively managed mutual funds are your only option. When buying shares of index funds and mutual funds in a retirement plan, there are generally no minimum purchase requirements.

Saving for retirement in an IRA gives you access to a wide variety of ETFs and index funds. If you invest extra money in a taxable investment account through an online broker, you will likely have access to all available funds and ETFs. In this case, minimum investment amounts and the availability of fractional shares may affect your choice of an ETF versus an index fund.

Should you invest in an ETF or managed funds?

Ultimately, the choice between an ETF and an index fund is probably less important than deciding to invest for your long-term goals using a passive investment vehicle. Whether you choose an index ETF, index mutual fund, or managed fund, you'll benefit from the lowest costs, diversification, and historically outperforming index investing.

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(Video) ETF (Exchange Traded Fund) vs Mutual Funds ? What is the Difference ? Bharat Bond ETF


ETF vs Index Fund: What's the difference? ›

ETFs are more tax-efficient than index funds by nature, thanks to the way they're structured. When you sell an ETF, you're typically selling it to another investor who's buying it, and the cash is coming directly from them. Capital gains taxes on that sale are yours and yours alone to pay.

Is it better to invest in ETF or index fund? ›

ETFs are more tax-efficient than index funds by nature, thanks to the way they're structured. When you sell an ETF, you're typically selling it to another investor who's buying it, and the cash is coming directly from them. Capital gains taxes on that sale are yours and yours alone to pay.

Is S&P 500 an ETF or index fund? ›

Overview: The SPDR S&P 500 ETF is the granddaddy of ETFs, having been founded all the way back in 1993.

What is the key difference between an ETF and a mutual or index fund? ›

With a mutual fund, you buy and sell based on dollars, not market price or shares. And you can specify any dollar amount you want—down to the penny or as a nice round figure, like $3,000. With an ETF, you buy and sell based on market price—and you can only trade full shares.

What is the main advantage of index ETFs over index mutual funds? ›

ETFs are generally more tax efficient than mutual funds. While you will pay capital gains taxes on any gains you realize when you sell shares of an index fund or an ETF, you do not pay taxes when the holdings in the ETF portfolio are adjusted by managers.

What is safer ETF or index fund? ›

Neither an ETF nor an index fund is safer than the other, as it depends on what the fund owns. Stocks will always be risker than bonds, but will usually yield higher returns on investment.

What is the downside of ETF funds? ›

The single biggest risk in ETFs is market risk. Like a mutual fund or a closed-end fund, ETFs are only an investment vehicle—a wrapper for their underlying investment. So if you buy an S&P 500 ETF and the S&P 500 goes down 50%, nothing about how cheap, tax efficient, or transparent an ETF is will help you.

Do ETF pay dividends? ›

There are 2 basic types of dividends issued to investors of ETFs: qualified and non-qualified dividends. If you own shares of an exchange-traded fund (ETF), you may receive distributions in the form of dividends. These may be paid monthly or at some other interval, depending on the ETF.

Is Vanguard S&P 500 ETF a good investment? ›

Vanguard S&P 500 ETF holds a Zacks ETF Rank of 2 (Buy), which is based on expected asset class return, expense ratio, and momentum, among other factors. Because of this, VOO is a great option for investors seeking exposure to the Style Box - Large Cap Blend segment of the market.

How many index funds should I own? ›

Experts agree that for most personal investors, a portfolio comprising 5 to 10 ETFs is perfect in terms of diversification. But the number of ETFs is not what you should be looking at. Rather, you should consider the number of different sources of risk you are getting with those ETFs.

What are 3 disadvantages to owning an ETF over a mutual fund? ›

So it's important for any investor to understand the downside of ETFs.
  • Disadvantages of ETFs. ETF trading comes with some drawbacks, which include the following:
  • Trading fees. ...
  • Operating expenses. ...
  • Low trading volume. ...
  • Tracking errors. ...
  • Potentially less diversification. ...
  • Hidden risks. ...
  • Lack of liquidity.

Why choose an ETF over a mutual fund? ›

Exchange-traded funds (ETFs) take the benefits of mutual fund investing to the next level. ETFs can offer lower operating costs than traditional open-end funds, flexible trading, greater transparency, and better tax efficiency in taxable accounts.

Which is the best index fund to invest in? ›

  • HDFC Index Fund Nifty 50 Plan-Direct Plan. ...
  • IDBI Nifty 50 Index Fund Direct Growth. ...
  • Motilal Oswal Nifty Smallcap 250 Index Fund Direct Growth. ...
  • Motilal Oswal Nifty 500 Fund Direct Growth. ...
  • Axis Nifty 100 Index Fund Direct Growth. ...
  • Sundaram Nifty 100 Equal Wgt Dir Gr. ...
  • IDBI Nifty Next 50 Index Fund Direct Growth.

Why you should only invest in index funds? ›

Over the long term, index funds have generally outperformed other types of mutual funds. Other benefits of index funds include low fees, tax advantages (they generate less taxable income), and low risk (since they're highly diversified).

What is the main disadvantage of investing in index funds? ›

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).

Why you should just invest in index funds? ›

Because actively managed funds often underperform the market, and index funds match it, passively managed index funds typically bring their investors better financial returns over the long term. Plus, they cost less, as management fees for actively managed investments tend to be higher.

What is the safest index fund? ›

1. Vanguard S&P 500 ETF (VOO 0.06%) Legendary investor Warren Buffett has said that the best investment the average American can make is a low-cost S&P 500 index fund like the Vanguard S&P 500 ETF.

Is it okay to just invest in index funds? ›

If you're new to investing, you can absolutely start off by buying index funds alone as you learn more about how to choose the right stocks. But as your knowledge grows, you may want to branch out and add different companies to your portfolio that you feel align well with your personal risk tolerance and goals.

What is the difference between S&P 500 and S&P 500 ETF? ›

How Does an S&P 500 ETF Differ from an S&P 500 Index Fund? Both an index ETF and an index mutual fund passively track the S&P 500 index in order to duplicate its return. ETFs trade like stocks on exchanges, while mutual funds can be traded only at the end of each trading day.

Why is ETF not a good investment? ›

And remember, actively trading ETFs, as with stocks, can reduce your investment performance with commissions quickly piling up. Every ETF will also come with an expense ratio. The expense ratio is a measure of what percentage of a fund's total assets are required to cover various operating expenses each year.

How long should you hold an ETF? ›

Holding period:

If you hold ETF shares for one year or less, then gain is short-term capital gain. If you hold ETF shares for more than one year, then gain is long-term capital gain.

Are ETFs a good investment for retirees? ›

Bottom Line. ETF benefits, including simplicity, low expenses and tax efficiency, make ETFs a worthwhile investment for retirement. Popular types of ETFs for retirement include dividend ETFs, fixed-income ETFs and real estate ETFs.

Which ETF has the highest return? ›

100 Highest 5 Year ETF Returns
SymbolName5-Year Return
XLKTechnology Select Sector SPDR Fund19.24%
QCLNFirst Trust NASDAQ Clean Edge Green Energy Index Fund19.15%
TQQQProShares UltraPro QQQ18.98%
VGTVanguard Information Technology ETF18.45%
91 more rows

What is the highest dividend paying ETF? ›

Top 100 Highest Dividend Yield ETFs
SymbolNameDividend Yield
FLRUFranklin FTSE Russia ETF24696.43%
SOGUAXS Short De-SPAC Daily ETF75.07%
PYPTAXS 1.5X PYPL Bull Daily ETF59.92%
KBAKraneShares Bosera MSCI China A 50 Connect Index ETF50.70%
91 more rows

What is the highest paying dividend stock that pays monthly? ›

High-Yield Monthly Dividend Stock #4: AGNC Investment Corporation (AGNC) High-Yield Monthly Dividend Stock #3: PermRock Royalty Trust (PRT) High-Yield Monthly Dividend Stock #2: ARMOUR Residential REIT (ARR) High-Yield Monthly Dividend Stock #1: Orchid Island Capital (ORC)

What is Vanguard's best-performing ETF? ›

Best Diversified ETF: Vanguard Total Stock Market ETF (VTI)

The Vanguard Total Stock Market ETF tracks the performance of the overall U.S. stock market. A large-blend ETF, it currently offers returns over 8%, making it one of the best-performing stocks on this list.

How can I invest 1000 dollars for a quick return? ›

Here are nine top ways to invest $1,000 and the key things to know about them.
  1. Buy an S&P 500 index fund. ...
  2. Buy partial shares in 5 stocks. ...
  3. Put it in an IRA. ...
  4. Get a match in your 401(k) ...
  5. Have a robo-advisor invest for you. ...
  6. Pay down your credit card or other loan. ...
  7. Go super safe with a high-yield savings account.
Feb 1, 2023

How many S&P 500 ETFs should I buy? ›

You only need one S&P 500 ETF

All three of the ETFs listed here have lower-than-average expense ratios and offer an easy way to buy a slice of the U.S. stock market. You could be tempted to buy all three ETFs, but just one will do the trick.

How long should you stay in an index fund? ›

Ideally, you should stay invested in equity index funds for the long run, i.e., at least 7 years. That is because investing in any equity instrument for the short-term is fraught with risks. And as we saw, the chances of getting positive returns improve when you give time to your investments.

What is the 4 rule for index funds? ›

How the 4% Rule Works. The 4% rule is easy to follow. In the first year of retirement, you can withdraw up to 4% of your portfolio's value. If you have $1 million saved for retirement, for example, you could spend $40,000 in the first year of retirement following the 4% rule.

What is the 80 20 rule for index funds? ›

80% of your portfolio's losses may be traced to 20% of your investments. 80% of your trading profits in the US market might be coming from 20% of positions (aka amount of assets owned). 80% of the US stock market capitalisation comes from around 20% of the S&P 500 Index.

Should I switch my mutual funds to ETFs? ›

If you're paying fees for a fund with a high expense ratio or finding yourself paying too much in taxes each year because of undesired capital gains distributions, switching to ETFs is likely the right choice for you.

What happens if an ETF closes? ›

You're forced to sell or take liquidation proceeds, which can create a tax burden or lock in investment losses. You may incur a capital gains tax on profits if the ETF's in a taxable account, that is, a non-retirement account. If you owned the fund less than a year, the profit will be taxed at your normal tax rate.

Are ETFs good for beginners? ›

Are ETFs good for beginners? ETFs are great for stock market beginners and experts alike. They're relatively inexpensive, available through robo-advisors as well as traditional brokerages, and tend to be less risky than investing individual stocks.

What is the downside of ETF vs mutual fund? ›

No-load mutual funds are also available, but these will charge other fees, such as annual expense ratios. Taxes: The biggest difference between mutual funds and ETFs when it comes to taxes is that mutual funds tend to create a lot of capital gains for clients, while ETFs don't.

Why are ETFs so popular? ›

ETFs are considered to be low-risk investments because they are low-cost and hold a basket of stocks or other securities, increasing diversification. For most individual investors, ETFs represent an ideal type of asset with which to build a diversified portfolio.

When should I choose an index fund? ›

Investors can be better off going with index funds over active funds as in most of the categories active funds have been unable to outperform their benchmark index consistently. There are multiple index funds replicating the same index. For example, there are more than 18 index funds that track NIFTY 50.

What is the average index fund return? ›

Over the past 30 years, the S&P 500 index has delivered a compound average annual growth rate of 10.7% per year.
S&P 500 annual returns.
YearS&P 500 Return
28 more rows

Which ETF has the highest 10 year return? ›

The best performing ETFs of the last 10 years are the iShares Semiconductor ETF (SOXX) with +596%, the iShares U.S. Medical Devices ETF (IHI) with +317.41% and the First Trust NASDAQ Clean Edge Green Energy Index Fund (QCLN) with +228.47%.

What's the safest form of investment? ›

What are the safest types of investments? U.S. Treasury securities, money market mutual funds and high-yield savings accounts are considered by most experts to be the safest types of investments available.

Are index funds still the best? ›

Index funds are still the right choice for many investors, despite the potential harm to the universe of investors as a whole, because they still offer very real benefits to individual investors, Zame says.

What if everyone invested in index funds? ›

For example, if everyone buys index funds, the values of the stock prices of the underlying companies won't reflect the fair value of the companies in the stock market. Instead the prices of stocks will simply reflect the the inflow of funds to indexes.

What is a better investment than index funds? ›

ETFs are more tax-efficient than index funds by nature, thanks to the way they're structured. When you sell an ETF, you're typically selling it to another investor who's buying it, and the cash is coming directly from them.

Are index funds taxed? ›

Index mutual funds & ETFs

Index funds—whether mutual funds or ETFs (exchange-traded funds)—are naturally tax-efficient for a couple of reasons: Because index funds simply replicate the holdings of an index, they don't trade in and out of securities as often as an active fund would.

Why is it smarter to invest in index funds rather than individual stocks? ›

The biggest difference between investing in index funds and investing in stocks is risk. Individual stocks tend to be far more volatile than fund-based products, including index funds. This can mean a bigger chance for upside … but it also means considerably greater chance of loss.

Why does Warren Buffett recommend index funds? ›

Buffett recommends passive and low-cost index funds because he believes this is the most rational way to invest for most people. There are so many forms of mistakes ordinary investors can make, but passive index investing limits those risks massively.

Why do people like index funds? ›

Index funds are a low-cost way to invest, provide better returns than most fund managers, and help investors to achieve their goals more consistently. On the other hand, many indexes put too much weight on large-cap stocks and lack the flexibility of managed funds.

Is a Roth IRA an index fund or ETF? ›

A Roth IRA is a type of tax-advantaged retirement account, while an index fund is a type of investment that tracks a market index. Index funds are popular choices for Roth IRAs and other investment accounts. A Roth IRA is a popular choice for investors because withdrawals are tax-free in retirement.

Are index funds really the best way to invest? ›

Most experts agree that index funds are very good investments for long-term investors. They are low-cost options for obtaining a well-diversified portfolio that passively tracks an index.

Why is it better to invest in ETF? ›

ETFs have several advantages over traditional open-end funds. The 4 most prominent advantages are trading flexibility, portfolio diversification and risk management, lower costs, and tax benefits.

Is it OK to only invest S&P 500 Index Fund? ›

That said, you shouldn't necessarily invest exclusively in the S&P 500. There are other indices, sectors, and groups of stocks you can invest in through mutual funds and ETFs, and there are some excellent individual stocks you can invest in.

Is S&P 500 equal weight ETF better than S&P 500? ›

S&P 500 Equal Weight Index had annualized performance of 11.12% versus S&P 500 Index's annualized performance of 9.89%. From when RSP was incepted (4/24/2003) through 3/31/2023, the fund outperformed the S&P 500 Index by 0.82% (annualized return at net asset value (NAV) of 10.83% vs 10.01%, respectively).

Are ETFs good for retirement accounts? ›

Bottom Line. ETF benefits, including simplicity, low expenses and tax efficiency, make ETFs a worthwhile investment for retirement. Popular types of ETFs for retirement include dividend ETFs, fixed-income ETFs and real estate ETFs.

What are the best index funds for a Roth IRA? ›

1. S&P 500 index funds. One of the best places to begin investing your Roth IRA is with a fund based on the Standard & Poor's 500 Index. It's a collection of hundreds of America's top companies, including many of the names you know and use every day (Amazon, Apple and Microsoft, for example).

Should you hold ETFs in an IRA? ›

IRAs allow investors to buy individual stocks, bonds, ETFs, or mutual funds. ETFs are becoming increasingly popular since they are excellent tools for building a diversified retirement portfolio at a low cost. Furthermore, income-paying ETFs are better suited for an IRA since income is deferred or sheltered from taxes.

Why not to invest in index funds? ›

While indexes may be low cost and diversified, they prevent seizing opportunities elsewhere. Moreover, indexes do not provide protection from market corrections and crashes when an investor has a lot of exposure to stock index funds.

Is it smart to just invest in ETFs? ›

If you're looking for an easy solution to investing, ETFs can be an excellent choice. ETFs typically offer a diversified allocation to whatever you're investing in (stocks, bonds or both). You want to beat most investors, even the pros, with little effort.

Why are ETF so popular? ›

ETFs are considered to be low-risk investments because they are low-cost and hold a basket of stocks or other securities, increasing diversification. For most individual investors, ETFs represent an ideal type of asset with which to build a diversified portfolio.

How much should I invest in ETFs? ›

Experts agree that for most personal investors, a portfolio comprising 5 to 10 ETFs is perfect in terms of diversification. But the number of ETFs is not what you should be looking at. Rather, you should consider the number of different sources of risk you are getting with those ETFs.


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