Index Funds or ETFs?
Written By: Nick Nguyen | Read full profile
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Here’s the short and skinny. Index Funds and their ETF equivalents are exactly the same. That’s right, they have the same portfolio, essentially the same returns, managed by the same hedge fund managers...but there’s a few small differences.
Index funds are well...funds. If you want a more detailed answer of what these are, check out my other post here and how you can essentially be investing like a pro using these here. But the idea is that when you invest in index funds, you’re essentially giving a fund manager more money that goes into this giant account of millions of dollars that’s used to buy shares of companies. Since you put some money in, you get a percentage of equity and dividends back!
What made index funds so great was that you could essentially buy all the stocks, bonds, real estate, etc. on the market through one investment at whatever you could afford. That’s right, you could throw in $10 or $10,000. Just make sure you check with your brokerage if there are any fees, minimums, and/or commissions*.
*Some brokerages like Vanguard have a minimum of $3000 to invest in their index funds like VTSAX or VFIAX.
This was great—before fractional shares became a thing.
Which brings us to ETFs. These stand for “Exchange Traded Funds.” Basically, some brokerages decided that instead of just letting you throw money into a pot, they’d instead bundle the portfolio up under an “ETF” label and sell it to you as a stock.
So what’s the difference?
Well, before fractional shares were a thing, ETFs weren’t so great because you had to buy a WHOLE share. Let’s take for example VFIAX. This is Vanguard’s S&P 500 Index Fund.
It was trading at $35.63 by end of day December 7th, 2020. But, if you didn’t have $35.63 to buy a whole share, no worries! You could’ve also just dropped $10 into that pot.
But, Vanguard’s exact same ETF version of the S&P 500 index is VOO.
↬ Exchange Traded Funds…What’s That?
↬ Using Index Funds to Invest Like a Pro!
↬ Which brokerage should I use for my IRA?
↬ 10 Popular ETFs that EVERY Investor Knows About
↬ Index Funds vs. Mutual Funds: The Short and Skinny
↬ Comparing Index Funds for Fidelity, Charles Schwab, and Vanguard
It cost $339.18 on December 7th. So to own it, you’d have to pony up $339.18! At least, that was the case before 2020. Now, a lot of brokerages like Fidelity, M1 Finance, and Robinhood have fractional shares, so you could essentially buy an ETF the same way you would an index fund.
So there’s got to be other differences right?
Yup. Remember how I said that VFAIX was $35 at the END of the trading day? That’s because you don’t know what the price of the index fund is until the end of the day. So even if you place an order in the morning, if the market suddenly skyrockets, you wouldn’t get yesterday’s price. You’d get the price at the end of the day.
ETFs on the other hand are like stocks. If you’re a bit fuzzy on what these are, here’s our post that gives you a run-down. But, the idea is you can track the price real-time and set Stop/Limit orders to purchase them at the prices you’re comfortable with!
And believe it or not, there are quite a few advantages to ETFs! VTI, the ETF version of Vanguard’s Total Stock Market Index, VTSAX, has a 0.01% lower expense ratio! And on top of that ETFs have a special way of managing tax efficiency. But where they really come in handy for advanced traders is when you can use them to write covered calls—but more on that in later posts.
The downside is that it’s a bit harder to automatically invest in ETFs compared to index funds. Some brokerages have it set up so you can buy a fractional share of an ETF automatically, but it’s not the most ideal, whereas most brokerages let you automatically buy a dollar-amount of an index fund at a specified time each month.
Long-story short: there are virtually no differences between index funds and ETFs now with fractional shares. It all comes down to how hands-on you want to be with your investing approach.
**Disclaimer: Not all index funds have an ETF equivalent, and vice versa. Vanguard is really popular because they have ETF versions of their index funds, but other ETFs may not have an equivalent index fund provided through the same brokerage.
*Nguyening Lifestyles is not a registered financial service provider and does not give financial advice. All information in these posts are for entertainment purposes only. Nguyening Lifestyles is not liable for any actions or outcomes that transpired after your reading of the following post.
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