How Does an Index ETF Work?
As with any investment vehicle, you’ll need to consider the access, fees, liquidity, risk, and taxes before making a decision.
· Access: Mutual funds can be difficult to get into, with minimal investments of $10,000 or more. By contrast, index ETFs can be purchased without any minimum requirements.
· Fees: The fee structure of index ETFs are comparable to the cheapest no-load index mutual funds. Because they are passively managed, the expense ratios are minimal compared to other diversified investment vehicles. Standard commission rates apply, charged when buy or sell orders are made. Many brokers do offer a selection of commission-free ETFs, however.
· Liquidity: Unlike mutual funds redeemed at the Net Asset Value once at the closing of each day, index ETFs can be bought and sold throughout the day on a major exchange.
· Risk: Like other ETFs, investors can diversify across sectors, thus decreasing risk. Investing in large companies mitigates the risk of volatility. Index ETFs can deviate from the underlying asset by as much as a percentage point.
· Tax Benefits: Capital gains taxes are only assessed on ETFs when the entire investment is sold. By comparison, mutual funds incur capital gains taxes every time the assets within the fund are sold.
What is the Difference Between an Index Fund and an ETF?
There are seven key differences between an index fund and an exchange traded fund:
– ETFs track indexes of a particular exchange.
– Index funds replicate the performance of a benchmark market index.
– ETFs trade like other stocks.
– Index funds trade like mutual funds.
– ETFs are priced like stocks based on supply and demand in the market.
– Index funds are priced like mutual funds based on NAV of the underlying asset.
4. Trading Costs
– ETFs have higher trading costs.
– Index funds have no transaction fees or commissions.
5. Expense Ratios
– ETFs have a low expense ratio ranging from 0.1-0.5%, adjusted to the price.
– Index funds have comparatively higher expense ratios.
6. Initial Investment
– ETFs have no minimum investment.
– Index funds typically require a few thousand dollars to get started.
7. Settlement Time
– ETFs take three days to settle.
– Index funds require just one day, offering holders quicker access to liquid cash after a sale.
The index exchange traded fund is a popular hybrid, offering investors lower fees, lower minimum investments, and more flexibility than traditional index mutual funds. Because the holdings in a given index are more transparent, index ETFs have prices closer to the value of the underlying shares, compared to traditional ETFs.
Contact the 6th Avenue Team at Ingalls & Snyder, LLC for advice on adding the index
If you have additional questions about index exchange traded fund investing or any other investment vehicles, contact the 6th Avenue Team. Our senior directors offer more than 50 years of combined investment management experience. We hope to have the opportunity to use our holistic approach to wealth management to help you reach your financial goals.
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