What is the difference between an ETF and an Index fund?

by Manshu on November 7, 2008

in Articles

The Big Difference

The main difference between an Exchange Traded Fund (ETF) and an Index fund is that an ETF can be traded on a stock exchange like a stock. You can buy or sell it at your will, and even short it.

As opposed to this, an Index fund cannot be bought from a stock exchange and has to be directly purchased from the mutual fund sponsor. You will not be able to trade it as freely as an ETF.

The Costs

Apart from this one difference listed above, there are no concrete differences between an Index Fund and an ETF tracking the same index as far as the retail investor is concerned.

An ETF may have lower costs (like no entry or exit loads) than an index fund, but you pay a bid-ask spread every time you buy an ETF which is non-existent in an Index fund. So, it can’t be said that one is cheaper than the other.

As far as comparison in returns is concerned, it is not a fair comparison to match one against the other so you can’t really say which one is better.

Warren Buffet’s view

According to this news article Warren Buffet tends to favor low cost Index Funds over ETFs. His rationale is very interesting. He says that ETFs present a temptation for retail investors to buy and sell very frequently and incur trading costs.

Index funds have no such temptations and will turn out to be cheaper and more profitable in the long run. According to Buffet, “I have nothing against ETFs, but I really think an index fund that just charges a few basis points for management is pretty hard to beat. You put it away, you have nobody encouraging you to trade it next week or next month … your broker isn’t going to be on you.”

Conclusion

If you were thinking of buying an ETF or an Index fund, then in all probability, you do have a sector that you want to buy in or you may just want to but the S&P 500. In such a scenario, it is best to look at various schemes and find out the one with the lowest cost.

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