ETFs and Their Differences From Mutual and Index Funds
Index funds have witnessed an increase in popularity among investors in the past decade. Even though these funds have minimal risks and passive investments, they’re considered potential investment options that are slowly gaining momentum. However, in the last few years, Exchange-Traded Funds (ETFs) have become the most preferred option among retail investors. Investors planning to trade must understand the difference between an exchange-traded fund and an index mutual fund. It is easier to trade in ETFs than in traditional mutual funds and index funds. Though both invest in similar portfolios, they use different investing methods.To make comprehensive decisions, we have outlined some of the differences between these investing instruments. Read on to find out!
What is an Exchange-Traded Fund?
ETF is a collection of assets traded like securities that track specific marketing areas. That is, it consists of multiple single securities that combine to form a bigger group. Investors can buy and sell these ETFs in an open exchange similar to regular stocks. On the other hand, mutual funds are only priced towards the end of the day. ETFs are a basket of several types of investments like bonds, stocks, commodities, or a mix of all these instruments. As they are marketable securities with a price attached, it is easier to buy and sell them later. You will come across different types of ETFs that are suitable for speculating, hedging, income generation, or avoiding risks on the portfolio. Some of the different ETF types are: • Currency ETF. • Bond ETF. • Inverse ETF. • Industry ETF. • Commodity ETF and much more. Though these investing instruments are similar to index mutual funds, they are primarily traded on the stock exchange.
What are Index Funds?
Index funds, otherwise called index mutual funds, contain an investment portfolio that matches or tracks with the constituents of the financial market indices. They represent the theoretical market segment that consists of small companies, companies segregated based on industries or large companies. Since index funds are not investable, it involves a passive form of investing regime that fixes rules on which stocks to include and then tracks them. Irrespective of the market conditions, these funds do not deviate from the set benchmark Index. Those in need of stable investment options can opt for index funds, as they promise long time returns with minimal risk.
What Makes an ETF Stand Out From The Index Mutual Fund?
Here are some features investors need to be aware of to make more effective investing decisions. • For ETFs, the share prices keep fluctuating throughout the day as they are bought and sold in the market. When it comes to mutual funds, it trades only once a day after the market closes. • Similar to index funds, ETFs also have a lower expense ratio when compared with actively managed funds. • ETS consists of numerous international and domestic investment varieties that contain bones, commodities, stocks, etc.
Major Differences between ETFs and Index Mutual funds
Though ETFs and index funds offer similar benefits to the investor, you will come across a few distinctions that set both these investing instruments apart.• Structure:ETFs are mutual funds traded on the stock exchanges like Sensex or Nifty and can track the specific indices. As a part of the debts and liquid assets keep varying from one EFT to another, the returns from each EFT differ even if they come under the same market index.Whereas index funds are similar to mutual funds and are capable of tracking the specific index. They replicate the stock market index and do not have any liquidity. This results in a higher number of assets in the form of cash and liquid assets than ETFs. • Investment Requirements:The majority of the ETFs have low minimum investment when compared with index funds. In most cases, to invest in an ETF, you only have to purchase a single share. When it comes to index funds, Brokers often place a minimum investment rate which is quite higher than the typical share value. For instance, Vanguard has set a minimum investment value of $3000 for most index funds, whereas T. Rowe Price has put a minimum investment rate of $2500 for the initial investment. • Net Asset Value (NAV):The net asset value for ETFs is in real-time, while it’s at the end of the day for index funds. • Settlement time:ETFs have three days to make their settlement, while index funds have only one day as settlement time.• Transaction charges:ETFs, charge only a minimum transaction fee of 0.5% and 1% as maintenance charges on the Demat account. Therefore, these funds do not have any recurring transaction charges. On the other hand, index funds charge a minimum expense ratio between 1% to 1.8%. Additionally, investors must also pay a fixed transaction charge for every investment they make above a certain limit.
Facts about ETFs
• Due to its benefits, the number of ETFs across the globe has seen a whooping growth of 2650% in this last decade. • Being the success story of the modern trading market, ETFs trade about $100 billion each day and have only a weighted average spread of 1.7 cents as of Jan 2020. • As per the investment data, there exists a minimum of 2,177 ETFs in the US as of 2020. The wide range of investment choices makes it a suitable option for young investors.• ETFs enable traders and investors to access diversified baskets by tracking their net asset value very well.• The value of assets managed by ETFs across the globe is around $7.74 trillion.• The largest ETF in the world, SPDR S&P 500, holds $327.31 billion by market capitalization.• ETF is the most preferred investment vehicle among young investors due to its unique characteristics that include: – Investment management choice. – Diversification. – Low fees. – Innovation. – Liquidity.
Comparing ETFs and index funds can be quite taxing, as they are quite similar. Choosing between the two depends upon which investment tool the investor prefers. A smart investor can use both these investment options wisely. You can use index mutual funds as your core holding and invest in ETFs of various industry sectors for diversity.