Distinguishing Characteristics of Index vs Exchange Traded Funds
The respective structures of index funds and ETFs overlap in a few areas, but those structures do display at least four key differences:
- Investment Fees and Expenses. Index funds typically have a higher expense ratio than ETFs. The company that manages an index fund takes a higher fee from the fund’s assets in order to compensate for the management that synchronizes the fund’s holdings with an underlying market index. ETFs are more passively managed, which results in a lower fee structure. Investors will pay brokerage commissions when they purchase and sell ETF shares, however, and those commissions can increase the expenses associated with ETF investments.
- Minimum Investments. Like virtually all mutual funds, index funds have certain minimum investment thresholds, typically a few thousand dollars or more. ETFs impose low or nominal minimums because they are traded like shares of stock. An investor can purchase a single ETF share if he or she is so inclined.
- Taxes on Investment Income. ETFs are generally considered more tax efficient than index funds because ETF shares are purchased and sold directly among investors in cash transactions. In contrast, an investor who wants to sell index fund shares will cause the fund’s management company to sell the fund’s underlying shares of stock, which can create capital gains tax consequences.
- ETFs can be purchased and sold on an intraday basis whenever markets are open. This feature gives active investors an opportunity to take advantage of short term daily ETF price swings. Unlike ETFs, index fund purchases and sales are set at prices that are in effect when a market closes.
Should I Invest in ETFS or Index Funds?
ETFs are traded like stocks and require a brokerage account to buy and sell them. On the other hand, an index fund can be bought and sold directly through the entity that formed and manages the fund.
Investors who are considering either of these financial products should make their decisions based on criteria other than whether they want to involve a broker in the transaction. An index fund’s or an ETF’s underlying character is much more critical. An investor can find index funds, for example, that track everything from broad market indexes , such as the Standard & Poor ‘s 500, down to more obscure indices, such as semiconductor or small market cap indices. Likewise, investors can find ETFs that track everything from industry sectors to foreign exchange markets and beyond.
Who Wins ETFS or Index Funds?
There is no clear winner in the debate between investing in ETFs or index funds. They are not mutually exclusive. Many investors will invest in both products to gain the advantages of each and to use one to reduce any drawbacks presented by the other.
Contact the 6th Avenue Team to Learn More About Investment Management Services
Ingalls & Snyder formed the 6th Avenue Team to provide investment management services to high net worth investors who want personalized investment advice, and a diverse, bespoke portfolio. Call to schedule an intake meeting and let us answer all of your questions about ETFs, index funds, and any other investment vehicles you are considering. Our advice is based on clear communication, a mutual understanding of your long-term goals, and a carefully considered, strategic plan for success.
1. www.time.com: What’s the Difference Between an Index Fund, an ETF, and a Mutual Fund? http://time.com/money/3938695/index-exchange-traded-funds-mutual-fund-difference/
2. www.investopedia.com: ETFs vs. Index Funds: Quantifying the Differences. https://www.investopedia.com/articles/mutualfund/05/etfindexfund.asp
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