#AskGradMoney: What is the Difference Between ETFs and Index Funds?
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SAM, NEW YORK:
"What is the difference between an ETF and an Index Fund? Are they the same or are there notable differences? Thanks."
It's quite easy to get confused by the terminology, but the two are in fact quite different from each other. First, ETFs are considered more flexible and more convenient than index funds. ETFs can be traded more easily than index funds and traditional mutual funds, similar to how common stocks are traded on a stock exchange -- in other words they trade intra-day.
In addition, investors can also buy ETFs in smaller sizes and with fewer hassles than index funds. By purchasing ETFs, investors can avoid the special accounts and documentation required for index funds, for example.
Differences in Cost
Other differences between index funds and ETFs relate to the costs associated with each one. Typically, there are no shareholder transaction costs for index funds. Costs such as taxation and management fees, however, are lower for ETFs. Most passive retail investors choose index funds over ETFs based on cost comparisons between the two. Passive institutional investors, on the other hand, tend to prefer ETFs. Investors can purchase ETFs that represent a particular index such as the S&P 500, or a particular sector of stocks (like auto companies).
How this relates to value investing
Compared to value investing, index fund investing is considered by financial experts as a rather passive investment strategy. Both of these types of investing are considered to be conservative, long-term strategies. Value investing often appeals to investors who are persistent and willing to wait for a bargain to come along. Getting stocks at low prices increases the likelihood of earning a profit in the long run. Value investors question a market index and usually avoid popular stocks in hopes of beating the market.
Hope this helps and good luck!