Megaphone icon ETF Database is now VettaFi. Read More >
ETFdb Logo
ETFdb Logo
  • ETF Database
  • Channels
    • Active ETF
    • Alternatives
    • Beyond Basic Beta
    • China Insights
    • Climate Insights
    • Commodities
    • Core Strategies
    • Crypto
    • Disruptive Technology
    • Dividend
    • Dual Impact
    • Emerging Markets
    • Energy Infrastructure
    • ESG
    • ETF Building Blocks
    • ETF Education
    • ETF Strategist
    • Fixed Income
    • Free Cash Flow
    • Future ETFs
    • Gold & Silver Investing
    • Innovative ETFs
    • Institutional Income Strategies
    • Leveraged & Inverse
    • Managed Futures
    • Modern Alpha
    • Multi-Asset
    • Portfolio Strategies
    • Retirement Income
    • Thematic Investing
    • Volatility Resource
  • Tools
    • ETF Screener
    • ETF Country Exposure Tool
    • ETF Sector Tracker Tool
    • ETF Database Categories
    • Head-To-Head ETF Comparison Tool
    • ETF Stock Exposure Tool
    • ETF Issuer Fund Flows
    • Indexes
    • Mutual Fund To ETF Converter
    • ETF Data for Journalists
    • ETF Nerds
  • Research
    • First Bitcoin ETF
    • ETF Education
    • Equity Investing
    • Dividend ETFs
    • Leveraged ETFs
    • Inverse ETFs
    • Top ETF Sectors
    • Top ETF Issuers
    • Top ETF Industries
  • Webcasts
  • Themes
    • AI ETFs
    • Blockchain ETFs
    • See all Thematic Investing ETF themes
    • ESG Investing
    • Marijuana ETFs
  • Videos & Podcasts
    • ETF 360 Video Series
    • ETF Trends on Videos
    • ETF Trends on Podcasts
    • ETF Prime Podcast
  • PRO
    • Pro Content
    • Pro Tools
    • Advanced
    • FAQ
    • Pricing
    • Free Sign Up
    • Login
  1. ETF Investing
  2. ETFs vs. Index Mutual Funds
ETF Investing
Share

ETFs vs. Index Mutual Funds

Sam BourgiAug 21, 2018
2018-08-21

The difference between an exchange-traded fund (ETF) and an index mutual fund is not as cosmetic as it might seem. Although both asset classes have unique advantages, deciding on what’s best for you requires due diligence and an objective assessment of one’s goals.

An index mutual fund provides broad exposure to the financial markets by tracking or matching the components of a market index, such as the S&P 500 or Nasdaq Composite Index. As a type of mutual fund, index funds usually provide low operating expenses, low portfolio turnover, and adherence to specific standards spanning tax management and the handling of tracking errors.

ETFs are similar to index mutual funds in that they provide ownership of an underlying asset and divide ownership of those assets into shares. However, they differ from index mutual funds along four important pillars, which are discussed below.

Differentiating ETFs From Index Mutual Funds

In terms of differences, ETFs and index mutual funds typically differ in fees, minimum investment requirement, taxation and liquidity.

1. Fees and Expenses

When it comes to expenses, ETFs have a slight advantage. For example, the Vanguard S&P 500 ETF (VOO A) has an expense ratio of 0.04%. A comparable index mutual fund, the Vanguard 500 Investor Shares (VFINX), has an expense ratio that is more than three times as high.

ETF holders traditionally had to pay commission to their brokers each time they bought and sold an asset, thus negating some of the cost advantages associated with the asset class. To overcome this obstacle and attract more people to the market, several big-name brokers like Vanguard and Charles Schwab have announced commission-free ETF trading. This appears to be the wave of the future as competition intensifies.

Click here to learn about the hidden costs of ETFs.

2. Minimum Investments

ETFs also have a slight advantage when it comes to minimum investments. Investors can access an ETF with as little as one share, with Charles Schwab offering an initial minimum of just $1. Mutual funds, on the other hand, usually require a minimum initial investment of between $500 and $3,000.

3. Taxes

When it comes to tax efficiency, ETFs and index mutual funds are virtually on equal footing, as both provide distinct advantages over actively managed funds. What’s more, tax payments are deferred as long as investors continue to hold the funds (in other words, capital gains taxes only apply once the funds are sold).

4. Liquidity

Although ETFs and index mutual funds are considered highly liquid, ETFs can be bought and sold any time during normal trading hours. Index mutual funds, on the other hand, are cleared after the market closes. Therefore, the transaction will be cleared hours after it was initially placed.


Content continues below advertisement

Trends in Index Mutual Funds and ETFs

Although ETFs have only been around since 1993, they have quickly emerged as one of the most popular investment vehicles on the market. Index mutual funds, which predate ETFs by several decades, have also enjoyed significant growth. By the end of 2017, index mutual funds and index ETFs together comprised 36% of total net assets in long-term funds, up from just 15% in 2007.

Below is a breakdown of index fund growth as a share of the overall fund market between 2007 and 2017. As you can see, index ETFs and index mutual funds have grown significantly.

ETFs vs Index Funds
Source: ici.org

In terms of actual numbers, 453 index mutual funds managed total net assets of $3.4 trillion in 2017. Index ETFs, on the other hand, managed total net assets of roughly $3.3 trillion.

On the ETF side, equity ETFs have grown particularly quickly over the past decade as more brokers and financial advisors integrate them into clients’ portfolios. Although bond ETFs are also growing, smaller bond funds have less-established secondary markets, which partially explains their small size relative to equity ETFs.

Use our Screener to find the right ETFs.

Advantages and Disadvantages of ETFs

From the perspective of passive investors, below is a breakdown of the advantages and disadvantages of ETFs.

Advantages

  • Diversification: One of the core benefits of ETF investing is diversification. One fund can give an investor exposure to a group of equities or a specific slice of a market or region.
  • Lower fees: When compared with actively managed funds, ETFs have much lower expense ratios.
  • Tax advantages: ETFs are among the most tax-efficient assets insofar as they are held by the investor. Capital gains taxes only apply once the investor sells the ETF.
  • Trade like a stock: Like equities, ETFs can be purchased on margin, sold short, and traded in the futures and options market.

Disadvantages

  • Hidden costs: ETFs have low expense ratios but carry other direct and indirect costs, such as commissions and management fees.
  • Often limited to larger companies: Depending on where you are investing, some ETFs offer limited exposure to small- and mid-cap companies, leaving the investor overexposed to large-cap companies.
  • Lower dividend payments: Investors can earn dividends by investing in dividend-paying ETFs, but the yield is typically lower than owning the stock outright.

Advantages and Disadvantages of Index Mutual Funds

Similar to the above section, the following provides an overview of the advantages and disadvantages of index mutual funds.

Advantages

  • Diversification: Index mutual funds offer the same diversification benefits of ETFs.
  • Lower fees: Although index mutual funds typically carry higher expense ratios than ETFs, they are much cheaper than actively managed funds.
  • Low risk: Compared with other asset classes, index mutual funds offer steady growth in a low-risk environment. Additionally, index funds typically outperform most non-index funds that are designed to beat the market.
  • Tax advantage: Like ETFs, index mutual funds have limited exposure to capital gains tax.

Disadvantages

  • Lack of flexibility: Since index mutual funds are designed to perform in lockstep with an index, they enjoy less flexibility than other asset classes.
  • Lack of big gains: If you invest in an index mutual fund, do not expect to outpace the market as they are not designed to do so. This makes big gains harder to come by.

Be sure to check our News section to keep track of recent fund performances.

The Bottom Line

As the size and growth rates of these markets demonstrate, ETFs and index mutual funds both carry significant advantages for passive investors. Regardless of which asset class you prefer, it’s important to evaluate each fund individually to determine if it meets your criteria for cost, structure, past performance and tracking error.

For more ETF news and analysis, subscribe to our free newsletter or sign up for ETFdb Pro to get access to our ETF Guides.

» Popular Pages

  • Tickers
  • Articles

Aug 17

An Advisor’s Guide to the Onshore China Real Estate Rally

Aug 17

China Getting Closer to Affordable Self-Driving Taxis

Aug 17

Inflation Reduction Act Could Lift Corn Prices

Aug 17

ETF Leaders Powered by the NYSE: William Rhind

Aug 17

Apple Has Avenues for Upside

Aug 17

No High Premium for ESG Bond Exposure With This ETF

Aug 17

ESG Critics Are Frequently Vocal, Not Always Successful

Aug 17

Big Name Throws Weight Into Crypto Evolution

Aug 17

Gold Miners Might Be a Potential Contrarian Play

Aug 17

Biotech Bounce-Back Might Be Durable

QQQ

Invesco QQQ Trust

SPY

SPDR S&P 500 ETF Trust

VOO

Vanguard S&P 500 ETF

SCHD

Schwab US Dividend Equity ETF...

JEPI

JPMorgan Equity Premium...

VGT

Vanguard Information...

VTI

Vanguard Total Stock Market...

VNQ

Vanguard Real Estate ETF

XLK

Technology Select Sector SPDR...

VYM

Vanguard High Dividend Yield...

Loading Articles...
Help & Info
  • Contact Us
  • Mission Statement
  • Press
Tools
  • ETF Screener
  • ETF Analyzer
  • Mutual Fund to ETF Converter
  • Head-To-Head ETF Comparison
  • ETF Country Exposure Tool
  • ETF Stock Exposure Tool
  • ETF Performance Visualizer
  • ETF Database Model Portfolios
  • ETF Database Realtime Ratings
  • ETF Database Pro
More Tools
  • ETF Launch Center
  • Financial Advisor & RIA Center
  • ETF Database RSS Feed
Explore ETFs
  • ETF News
  • ETF Picks of the Month
  • ETF Category Reports
  • Premium Articles
  • Alphabetical Listing of ETFs
  • Best ETFs
  • Browse ETFs by ETF Database Category
  • Browse ETFs by Index
  • Browse ETFs by Issuer
  • Compare ETFs
Legal
  • Terms of Use and Privacy Policy
  • © ETF Flows LLC
Follow ETF Database
Follow ETF Database

Advertisement

Is Your Portfolio Positioned With Enough Global Exposure?

ETF Education Channel

How to Allocate Commodities in Portfolios

Tom LydonApr 26, 2022
2022-04-26

A long-running debate in asset allocation circles is how much of a portfolio an investor should...

Core Strategies Channel

Why ETFs Experience Limit Up/Down Protections

Karrie GordonMay 13, 2022
2022-05-13

In a digital age where information moves in milliseconds and millions of participants can transact...

}
X