20+ Differences between ETF and Index Fund (Explained)

Investing and trading can be so difficult at times, especially when you do not have proper financial knowledge.

When an individual has no prior experience in investing in various financial securities, it is always best to first invest in various funds such as Exchange Traded Funds and Index Funds. The former is concerned with following indexes of various stock exchanges, while the latter is concerned with copying or recreating the performance of various indexes.

Key Differences

ETF

It is an abbreviation for Exchange Traded Funds. It refers to a group or bunch of securities traded by following various stock exchange indexes.
These funds are traded very much like stocks, i.e., through a stock exchange. Due to this very reason, they are referred to as Exchange Traded Funds.
Since these are traded through stock exchanges; thus, their buying and selling are carried out all the time until the stock market closes.
Since these funds can be traded anytime during the working hours of the stock market, the prices of these funds keep on updating or changing throughout the day.

Index Fund

It refers to a group or bunch of securities that work by recreating or copying the performance of the index of various stock exchanges.
These funds come into the mutual fund category; thus, they are not traded through stock exchanges. Just like mutual funds, these funds are traded only at the end of the day.
The trading of these funds takes place after the closing of the stock markets, i.e., at the end of the day.
Since these funds can only be traded once a day, the prices of these funds only update or change once a day.

Comparison Between ETFs And Index Funds

Parameter	ETF	Index Fund
Meaning	It refers to a group or bunch of securities that work by following or tracking the performance of various indexes. These funds resemble stocks very much and are traded like them, also.	It refers to a group or bunch of securities that work by trying to recreate or copy the performance of indexes of stock exchanges. These funds are considered a part of mutual funds and are traded very much like them.
Types	These funds can be broadly categorized into Active & Passive, Stock, Bond, Industry or Sector, Commodity, Currency, Inverse, and Leverage ETFs.	It does not have any types.
Trading	Since these funds resemble stocks, they are traded exactly like them, i.e., through stock exchanges. The trading of these funds takes place every day until the stock markets close.	Since these funds are a part of mutual funds, they are traded just like mutual funds are traded, i.e., at the end of the day after the stock markets close. Hence, their trading occurs only once a day at the end of the day.
Updating of prices	Since their trading keeps happening all the time until the closing of stock markets, their prices keep updating or changing throughout the day.	Since their trading happens only once a day, i.e., at the end of the day, their prices also update or change only once a day at the end of the day.
Middlemen	One generally has to contact brokers if anyone wants to invest in these funds.	One typically has to contact mutual funds companies if anyone wants to invest in these funds.
Minimum investment	One of the major advantages and surprising characteristics of these funds is that they do not demand any form of minimum investment to proceed forward, unlike most similar funds.	Since these funds are considered a part of mutual funds, these funds might demand some minimum investment to proceed ahead.
Management	These funds are considered to be passively managed. This means that these funds rely on stock exchange indexes to decide when and where to invest. Unlike Index Funds, these funds do not rely on various calculations and various trading tools. However, it should be noted these funds can be actively managed, and when that happens, the cost incurred in these funds ten to be bigger than passively managed funds.	These funds are considered to be actively managed. This means that these funds rely on various calculations and investment tools to decide when and where to invest. Unlike ETFs, these funds do not rely on the following indexes to make investment decisions.
Transparency	Compared with Index Funds, these funds are considered more transparent. This is because fund holdings are disclosed to the relevant parties daily.	In comparison with ETFs, these funds are considered to be less transparent. This is because fund holdings are disclosed to relevant parties every month.
Liquidity	These funds are considered to be more liquid than Index Funds.	These funds are considered to be less liquid than ETFs.
Fee	These funds’ combined fees are lesser than those involved in Index Funds. This is because the only fee that is associated with these funds is the brokerage fee.	These funds’ combined fees are more than those involved in ETFs. This is because, along with middlemen’s fees, these funds also have other types of fees known as the 12b-1 fee. This fee is associated with marketing purposes.
Expense ratio	These funds are known for their lower expense ratio. The reason behind their low expense ratio is a lower amount of fees and passive management.	These funds are known for their higher expense ratio. The reason behind their high expense ratio is a higher amount of fees along with active management.
Advantages	The major advantages of these funds are availability in many stock exchanges, non-required minimum investment, and no 12b-1 fee.	These funds’ major advantages include minimal minimum investment, professional management, and the average fee amount.
Disadvantages	The high costs of ETFs are actively managed, and less diversification are some of the major disadvantages of these types of funds.	These funds’ major disadvantages are inflexibility, high expense ratio, less transparency, and average gains.

Major Differences Between Etf And Index Fund

What exactly are ETFs?

These funds stand for Exchange Traded Funds, and these funds are named so because they are traded just like stocks, i.e., through Stock Exchanges. These funds work by following or tracking the indexes of stock exchanges.

Here, the tracking index means that the concerned provider normally buys securities estimated to have the same weight as in the concerned index to see or picture its performance. Since these funds are traded through stock exchanges, thus the trading of these funds keeps on happening until the closing of stock markets.

Features of Exchange Traded Funds (ETFs)

It refers to a bunch or group of financial securities or instruments whose performance relies on the performance of various indexes of stock exchanges. In simple terms, these funds work by tracking or following various indexes.
These funds are traded through stock exchanges, similar to how stocks are traded. Due to this reason, these securities can be traded at any given time during the day until the stock market closes.
Since these can be traded at any time, thus the prices of these securities keep on changing or updating throughout the day.
To invest in these funds, one generally has to contact a broker and pay the brokerage.
One of the classic features of these funds is that they do not require any minimum investment to proceed ahead.
One of the major advantages of these funds is that they have very high transparency, meaning the information relating to the funds’ allocation (also known as fund holding) is disclosed to relevant parties daily.
Along with offering high transparency, these funds are also known for their high liquidity.
These funds can be broadly categorized into eight types: Active & Passive, Stock, Bond, Industry or Sector, Commodity, Currency, Inverse, and Leverage.

What exactly are Index Funds?

These funds refer to a bunch or group of securities that work in an attempt to recreate or copy the performance of an index. So, for example, if an index is going down, then the prices or rates of these funds would also go down.

Similarly, if the concerned index goes up, the prices of these funds would also go up. These funds are referred to as a part of mutual funds, and just like mutual funds, these funds are also traded only once a day, i.e., at the end of the day after stock markets close.

Features of Index Funds

It refers to a bunch or group of financial securities that work in an attempt to recreate or copy the performance of an index.
These funds are considered very similar to mutual funds and are not traded through stock exchanges; instead, they are traded after the closing of the stock markets, i.e., at the end of the day.
Since these funds can only be traded at the end of the day, thus the prices of these funds change or update only at the end of the day.
One must contact a broker and pay the brokerage to invest in these funds like ETFs.
These funds are a category of mutual funds, and thus, these funds demand investors to make a minimum investment to proceed ahead.
When it comes to transparency, these funds are considered moderately transparent because their fund holdings are disclosed to relevant parties every month.
Along with offering moderate transparency, these funds are also known for offering moderate liquidity.

The Contrast Between ETFs And Index Funds

Meaning

ETF – It is an abbreviation for Exchange Traded Funds, which means a group of financial instruments or securities that work by tracking or following some specific indexes of recognized stock exchanges. These funds are traded very similarly to stocks, i.e., through stock exchanges.

Index Fund – It refers to a group of financial instruments or securities that work by trying to recreate or copy the performance of an index. These funds are considered a part of mutual funds and are traded just like mutual funds are.

Types

ETF – Active & Passive, Stock, Bond, Industry or Sector, Commodity, Currency, Inverse, and Leverage ETFs are the eight various types of these funds.

Index Fund – It does not have any types.

Types of ETFs

Active ETFs: As the name suggests, these types of ETFs are actively managed, meaning these funds do not rely on indexes.
Passive ETFs: These types of ETFs are completely opposite of Active ETFs as these are passively managed, meaning they typically rely on stock indexes.
Bond ETFs: These types of funds are concerned with investing in Bonds and helping clients generate a regular income through interest received on Bonds.
Stock ETFs: These types of funds are concerned with investing in several Stocks that usually belong to a particular sector. However, it should be noted that the stocks invested through ETFs do not result in the ownership of the client like usual stocks do.
Industry or Sector ETFs: These types of funds are concerned with investment in a particular or specific industry or sector.
Commodity ETF: As per the name, these types of funds are concerned with the investment in things that belong to various commodities. Commodities here could be anything, such as petroleum, gold, agricultural items, etc.
Currency ETFs: These types of funds are associated with investing in various currencies to give investors clear exposure to the same.
Inverse ETFs: These types of ETFs are concerned with making gains from the stocks that are expected to become lower in price. It works by first selling a stock at a higher price and then buying it again at a lower price.
Leveraged ETFs: These types of ETFs are concerned with increasing the return of those securities that come under underlying indexes.

Trading

ETF – Since these funds highly resemble stocks, they are traded exactly like stocks through stock exchanges. The trading of these funds takes place until the stock markets close.

Index Fund – The trading procedure of these funds is completely different from that of ETFs. Since these funds resemble mutual funds, they are traded exactly like mutual funds are. These funds are traded only once daily, after the closing of stock markets, i.e., at the end of the day.

Updation of prices

ETF – The prices of these funds are known for their frequent fluctuations than Index Funds. This is because the trading of these funds takes place until the closing of stock markets; thus, their prices keep on updating or changing all the time as and when their trading happens.

Index Fund – The prices of these funds change or update less frequently than ETFs. This is because trading these funds only occurs once a day after the stock markets closing or at the end of the day. Hence, their prices update or change only at the end of the day.

Middlemen

ETF – To invest in these funds, one typically has to contact brokers specializing in trading and investing in these funds. It should be noted that this process generally involves payment of a fee in the form of brokerage.

Index Fund – The middlemen involved in these funds are completely different from that of ETFs. Since these funds are considered a part of mutual funds, to invest in these funds, one generally has to get in touch with mutual funds companies.

Minimum investment

ETF – When people think of investing in any type of fund, they already assume that every fund would require some minimum investment. Still, surprisingly these funds do not require any form of minimum investment.

Index Fund – Since these funds are a type of mutual fund, in most cases, these funds require investors to make a minimum amount of investment.

Management

ETF – These funds are believed to be managed passively. When funds are passively managed, it means instead of doing lots of calculations and all the hard work relating to when and where to invest, these funds focus on an index and invest according to that concerned index. However, it should be noted that some ETFs are also present in the stock markets that are actively managed.

Index Fund – The management of these funds is completely different from that of ETFs. These funds are believed to be managed actively. This means that these funds rely on various calculations relating to when and where to invest instead of just following an index.

Transparency

ETF – These funds are considered to be more transparent than Index Funds. This is because the information relating to the allocation of funds, also known as fund holdings, is disclosed to all the relevant parties daily.

Index Fund – These funds are considered to be less transparent than ETFs. This is because the information relating to the allocation of funds is disclosed to all the relevant parties every month.

Fee

ETF – The fees involved in these funds are much lesser than those in Index Funds. The brokerage is the only fee an individual has to pay while investing in these funds.

Index Fund – The fees involved in these funds are more than those involved in ETFs. This is because, along with the middlemen fees, these funds also include a special type of fee known as the 12b-1 fee. This fee is concerned with marketing expenses.

Liquidity

ETF – Regarding liquidity, these funds are considered more liquid than Index Funds.

Index Fund – These funds are considered less liquid than ETFs.

Expense ratio

ETF – Since these funds include fewer fees than Index funds; thus the expense ratio associated with these funds tends to be lesser than the expense ratio of Index Funds. Along with low fees, passive management is another reason behind a low expense ratio. According to data from 2016, these funds’ expense ratio is estimated to be near 0.23 percent.

Index Fund – Since these funds include more fees than ETFs, the expense ratio of these funds tends to be more than the expense ratio of ETFs. Along with high fees, their active management is another reason behind their low expense ratio. The expense ratio of these funds is believed to range from 1 to 2.5 percent.

Advantages

ETF – The major advantage of these funds is that they have many stocks exchanged through which they can be traded. Along with that, their fee and expense ratio is also very low, and they do not even demand a minimum investment.

Index Fund – Minimal minimum investment, professional management, and the average fee are these funds’ major advantages.

Advantages of Exchange Traded Funds (ETFs)

More diversification.
Low fee.
Low expense ratio.
Requires no minimum investment
More transparency.

Advantages of Index funds

Minimal minimum investment.
Management by skilled professionals.
Low amount of fees.

Disadvantages

ETF – High costs if ETFs are actively managed and less diversification are some major disadvantages of these funds.

Index Fund – Inflexibility, high expense ratio, less transparency, and average gains constitute these funds’ major disadvantages.

Disadvantages of Exchange Traded Funds (ETFs)

Absence of cash holdings.
Less liquidity.
High fees if there is active management.

Disadvantages of Index funds

Inflexible
High expense ratio
Less transparency

CONCLUSION

Two of the most popular funds that have a close relationship with various indexes of stock exchanges are ETFs and Index Funds. Due to various similarities, both funds are often confused with one another.

The major difference between ETFs and Index Funds is that the former resemble stocks and are traded through stock exchanges, whereas the latter is a mutual fund traded only once after the stock markets close.

FREQUENTLY ASKED QUESTIONS (FAQs)

Q1. What are the different types of ETFs?

ETFs can be broadly categorized into eight types: Active & Passive, Stock, Bond, Industry or Sector, Commodity, Currency, Inverse, and Leverage ETFs.

Q2. What does it mean for any fund to be passively managed?

Instead of doing all the calculations and running theories to get an idea of when and where to invest, just following an index is done, then those funds are referred to as passively managed.

Q3. What are the major differences between EFTs and Index Funds?

The major difference between EFTs and Index Funds is that the former are traded through stock exchanges, carry lower expense ratios, and are highly transparent. Whereas the latter are traded after closing the stock markets, carry high expense ratios, and are moderately transparent.

Q4. Why are Index Funds associated with higher expense ratios?

These funds are associated with a higher expense ratio because, firstly, these funds have higher fees, including middlemen and 12b-1 fees. And Secondly, these funds are also actively managed.