Comparing ETFs to Index Funds, Trading ETFs Vs Index Funds

Monday, June 15, 2009

Comparing ETFs to Index Funds

Exchange traded funds (ETFs) and Index funds are different types of funds with almost same type of portfolio. Both passively track broad/specific indexes/sectors and try to go with the market. But as they are managed in different ways, they offer different returns, have different risk levels and suit different traders. Here is a comparison of ETFs and index funds.

Both have diversified portfolios.
ETFs suit almost all kinds of traders, institutional and retails, following most trading styles. But they (because of the trading costs involved) are less suitable for retail traders, who want to passively track the market.
Index funds usually suit retail traders, having less time/resource to manage their portfolio, because it does not need a brokerage account or transaction costs.
Most index funds are open end funds, which work by regularly creating and redeeming shares. But ETFs are devoid of these costs. For more info read Open End Funds Vs Closed End Funds.
Index funds need to hold some money as cash on their hands, while ETFs can invest the full amount on stocks. This too saves cost.
ETFs are traded like stocks, this means there is brokerage costs (which can vary with broker) and bid-ask-spreads. This can make them costly for a less-capital investor.
ETFs, which lesser security transactions are more tax savvy than index funds.
Index funds offer more advantages for dividend-loving trades. They almost readily reinvest/distribute the dividends, where as ETFs require to gather and distribute cash to shareholders on timely manner.