Index funds vs. ETFs: which fits your strategy?

Key takeaways

• An index fund is any fund that tracks a market index; it can be a mutual fund or an ETF. ETFs trade on an exchange like a stock.
• ETFs trade throughout the day at market prices; index mutual funds trade once a day at the closing net asset value.
• Both can be very low cost. Choose based on how you invest, not which label sounds better.

What they have in common

Index funds and exchange-traded funds both pool money from many investors to buy a basket of securities. Many follow the same benchmarks, such as the S&P 500 or a total-market index, so they offer instant diversification at a low cost.

How they trade

ETF shares are bought and sold on an exchange throughout the trading day, and the price can move minute to minute. Index mutual funds are bought from the fund company or a brokerage, and every order placed during the day is filled at the same end-of-day price, called the net asset value (NAV).

Minimums, automation and fractional shares

Some mutual funds require an initial minimum investment, while an ETF’s minimum is generally the price of one share — or less if your brokerage offers fractional shares. Mutual funds have long made it easy to invest a fixed dollar amount automatically, though many brokerages now offer the same for ETFs.

Costs and taxes

Expense ratios for broad index funds and ETFs can both be very low. In taxable accounts, ETFs are often more tax-efficient because of how shares are created and redeemed, which tends to limit capital gains distributions. In retirement accounts, that difference doesn’t matter.

• Compare the expense ratio — the annual fee as a percentage of your investment.
• Check for trading commissions, sales loads or account fees.
• Look at tracking difference: how closely the fund follows its index after costs.

Which should you choose?

If you like setting up automatic monthly investments of exact dollar amounts, an index mutual fund can be the simplest choice. If you want intraday trading, no minimums or slightly better tax efficiency in a taxable account, an ETF may fit better. For many long-term investors, either works well.

The bottom line

The index matters more than the wrapper. Pick a low-cost, diversified fund that matches your goals, invest regularly and avoid frequent trading.

Frequently asked questions