Investing in the sharemarket can be overwhelming, especially for early investors who are just starting.
If you’re in this situation, you might have come across the terms “index fund” and “ETF” and wondered what they mean.
In Australia, ETF and index funds have become increasingly popular in recent years as more investors look for a low-cost and diversified way to invest in the stock market.
But what’s the difference between an indexed fund and an ETF? We look at these common investing terms and explain what they mean.
What is an index fund?
An index fund is a type of investment fund that tracks a specific market index, such as the S&P/ASX 200 in Australia. The fund manager aims to replicate the performance of the index by investing in a similar proportion of each stock in the index.
This means that if the ASX 200 index rises by 5%, the value of an ASX 200 index fund should also rise by approximately 5%. Index funds aim to provide investors with exposure to a broad range of stocks, rather than trying to pick individual stocks themselves.
How does an index fund work?
Index funds work by investing in a range of stocks that are included in the index it tracks. The fund manager aims to replicate the index’s performance by holding a similar proportion of each stock in the index. This means that the fund’s performance will reflect the performance of the index it tracks.
Index funds are passively managed, which means that the fund manager does not actively
choose which stocks to invest in or when to buy or sell them. Instead, the fund manager simply buys and holds the stocks in the index, in the same proportion as the index.
What is an ETF?
An ETF (exchange-traded fund) is a type of investment fund that trades on a stock exchange, like a stock. ETFs can track a specific index, just like index funds. However, they can also track other assets, such as currencies, commodities or bonds.
ETFs are often traded like stocks, which means that they can be bought and sold on the ASX and Cboe. This can make them more flexible than index funds, which are often only priced once a day.
How do ETFs work?
ETFs work by owning a portfolio of assets that is designed to replicate the performance of an index, just like an index fund. However, unlike index funds, ETFs can be traded like a stock. This means that investors can buy and sell ETFs throughout the trading day, rather than waiting until the end of the day to make a trade.
What are the differences between indexed funds and ETFs?
While both indexed funds and ETFs can provide investors with a low-cost way to invest in the stock market, there are some key differences between them. Here are some of the main differences:
Structure
Indexed funds are typically managed funds or unit trusts that aren’t listed on an exchange. ETFs, on the other hand, are traded on a stock exchange like a stock. This means that ETFs can be bought and sold throughout the trading day, while index funds are priced at the end of the day.
Trading
As mentioned, ETFs can be traded like stocks, on an exchange like the ASX, which means that they can be bought and sold throughout the trading day (also known as intraday trading). This can make them more flexible than index funds, which are often only priced once a day and can only be bought at the end of the trading day.
Cost
The costs of investing in indexed funds and ETFs can vary. ETFs have a single management fee for all investors into the fund. This can be helpful for investors looking to invest smaller amounts since they get the same low fees as large investors. Index funds sometimes have higher fees for smaller investment amounts.
Index funds have historically had higher minimum entry levels, like $25,000. ETFs allow you to invest for as little as $500.
Diversification
Both indexed funds and ETFs offer diversification benefits, as they invest in a basket of stocks rather than a single stock. However, some ETFs can offer more specific diversification benefits than index funds, such as exposure to a specific sector or asset class.
So, which one is better – an index fund or an ETF? The answer ultimately depends on your personal investment goals and preferences. Stockspot recommends ETFs for their flexibility, access to various asset classes and liquidity.
If you have any questions about ETFs, index funds or investing in general, feel free to contact Stockspot, even if you are not a client. We’d be happy to take your call and answer any questions you might have.
