To start, we have to understand what is a mutual fund before we go over the differences between an Index fund and an Exchange-Traded fund.
What is an Index fund and an ETF
A mutual fund can be defined as an investment instrument managed by an investment company, which collects sums it receives from individual investors and invests them in various securities such as stocks, bonds, and money market instruments.
Once the mutual fund is constituted, there will be shares issued and distributed on a pro-rata basis to each investor.
The value of each share is called the net asset value, or NAV. Moreover, the fund can be set up as an open-end or a closed-end fund.
An open-end fund accepts new investors by issuing additional shares at their net asset value based on the daily closing price.
Additionaly, when investors in open-end funds do withdraw, their shares are brought back to the fund at NAV.
In the case of a closed-end fund, if you want to get your money back, you have to sell it to other investors already invested in the fund.
Now, we can start talking about the differences about our main subjects.
In tha case of an Index fund, you can define it as a form of mutual fund that tries to match the performance of a market index (For example the S&P500).
Like a mutual fund, an Index fund is a pooling of many individual investors’ money. More importantly, it’s an open-end fund.
An Exchanged-traded fund is a closed-end fund. Meaning that the shares will be traded on organized securities exchanges just like stocks.
As stated above being treated as stocks, you can receive dividends, short sales, and buy on margin.
Pros and cons of the funds
|Number of trade per day||Once||Continuously|
|Dividend||Paid to the fund||Paid directly to the investor|
|Purchased by margin||No||Yes|
Mainly, what new small investors have to consider is the brokerage fee.
Even though, the management fee is higher in an Index fund, in the case of an ETF if you invest 100$ monthly you can be charged with a 5$ brokerage fee every time you buy shares.
That is, you’ll already be behind (5$/95) 5.26% on your return, so if you’re just starting, you should go for the Index Fund.
Consequently, when your capacity to save increases, and makes brokerage fee negligible, you can go for an ETFs.
As a final note, Canadians can expect fees to go from 5$-10$, so it’s worth making a little research before you start putting money.