Index Mutual Funds
Indexfunds are funds that represent a theoretical segment of the market and aredesigned to act as the performance and make-up of a financial market index. Youcan't invest in an index itself, but you can invest in an index fund. When youdo so, you are utilizing a form of passive investing that sets rules by whichstocks are included, then tracks the stocks without trying to beat them.\
Thesetypes of funds follow a benchmark index, like the Nasdaq 100 or S&P 500,and index funds have lower expenses and fees than funds that are activelymanaged.
People interested in investing in an indexfund can generally do so through a mutual fund designed to mimic the index.
Exchange-TradedFunds (ETFs)
ETFsare baskets of assets traded like securities. They can be bought and sold on anopen exchange, just like regular stocks, as opposed to mutual funds, which areonly priced at the end of the day.
Other differences between mutual funds and ETFs relateto the costs associated with each one. Typically, there are no shareholdertransaction costs for mutual funds. Costs such as taxation and management fees,however, are lower for ETFs. Most passive retail investors choose index mutualfunds over ETFs based on cost comparisons between the two. Passiveinstitutional investors, on the other hand, tend to prefer ETFs.
Compared to value investing, index fund investing isconsidered by financial experts as a rather passive investment strategy. Bothof these types of investments are considered to be conservative, long-termstrategies. Value investing often appeals to investors who are persistent andwilling to wait for a bargain to come along. Getting stocks at low pricesincreases the likelihood of earning a profit in the long run. Value investorsquestion a market index and usually avoid popular stocks in hopes of beatingthe market.
ADVISOR INSIGHT
Will Thomas, CFP®, CIMA®, CTFA
The Liberty Group, LLC, Washington, DC
The confusion is natural, as both are passively managedinvestment vehicles designed to mimic the performance of other assets.
An index fund is a type of mutual fund that tracks aparticular market index: the S&P 500, Russell 2000, or MSCI EAFE (hence thename). Since there’s no original strategy, not much active management isrequired, and so index funds have a lower cost structure than typical mutualfunds.
Although they also hold a basket of assets, ETFs aremore akin to equities than to mutual funds. Listed on market exchanges justlike individual stocks, they are highly liquid: They can be bought and soldlike stock shares throughout the trading day, with prices fluctuatingconstantly. ETFs can track not just an index, but an industry, a commodity, oreven another fund.
What Is the Difference Between an ETF vs. Index Fund?
The main difference between an ETF and an index fund isETFs can be traded (bought and sold) during the day and index funds can only betraded at the set price point at the end of the trading day.
Do ETFs or Index Funds Have Better Returns?
ETFs and index funds historically have both performedwell. It may be wise to check the overall costs of each and compare them beforeyou decide where to invest your money.
Are ETFs or Index Funds Safer?
Neither an ETF nor an index fund is safer than theother, as it depends on what the fund owns. Stocks will always be risker thanbonds, but will usually yield higher returns on investment.
The Bottom Line
Both index mutual funds and ETFs can provide investorswith broad, diversified exposure to the stock market, making them goodlong-term investments suitable for most investors. ETFs may be more accessibleand easy to trade for retail investors as they trade like shares of stock onexchanges. They also tend to have lower fees and are more tax-efficient, onaverage.
